On July 7, 2017, OSFI released draft changes to Guideline B-20 - Residential Mortgage Underwriting Practices and Procedures for public consultation. The revisions reflect a further tightening of the mortgage rules, with the most substantial changes being focussed on intensifying credit decision procedures in the underwriting process and refining loan-to-value (LTV) ratio measurements. This follows OSFI's letter from July 2016 outlining its updated expectations with respect to the residential mortgage underwriting practices of federally regulated financial institutions (FRFIs). The changes align language in Guideline B-20 with OSFI's July 2016 letter and clarify and strengthen expectations in several areas.
Comments are to be provided by August 17, 2017, and it is anticipated that the revised Guideline will be effective later this year.
Credit Decision Procedures in the Underwriting Process
The existing Guideline B-20 includes a series of items that FRFIs should consider as part of their assessment of a borrower. The draft Guideline B-20 revises OSFI's guidance with respect to several of these items, and adds a few new items, including:
- Income Verification: FRFIs are advised to undertake "rigorous efforts" to confirm a borrower's income, especially for self-employed borrowers or in respect of foreign-source income. Additionally, FRFIs should be diligent when assessing temporarily high incomes (e.g., due to irregular commissions or bonuses) and when underwriting loans where repayment is dependent on the property itself (e.g., in the case of a rental property).
- Purpose of the Loan: FRFIs should ascertain and document the purpose of a prospective mortgage loan. This process should include determining (i) the intended use of the loan (purchase or refinancing), (ii) the type of purchase for which the loan is sought (owner-occupied residence, secondary property, etc.), and (iii) the type of refinancing (debt consolidation, renegotiation of existing loan agreement, etc.)
- Misrepresentations: OSFI also advises that FRFIs should have sufficient mechanisms in place to detect, prevent and report instances of misrepresentation encountered during the underwriting process.
Additionally, OSFI notes that a debt serviceability analysis, in line with the FRFI's residential mortgage underwriting policy (RMUP), should be part of the borrower's assessment. For insured mortgages, FRFIs should meet the debt serviceability requirements imposed by mortgage insurers, while for uninsured mortgages FRFIs should require that the minimum qualifying rate be at least the contractual mortgage rate plus 2%.
LTV Ratio Measurements
Draft Guideline B-20 sets out OSFI's expectation that an FRFI's LTV limit structure be consistent with (i) the risk profiles of the various residential mortgages it holds, and (ii) the FRFI's RMUP.
To support a nuanced and critical assessment of LTV ratios, OSFI organizes the risk-profiles of various mortgages in the draft Guideline B-20 according to a classification of mortgage loans as "conventional", "non-conforming", and "non-conventional". Conventional loans are loans with lower LTV ratios that typically do not require mortgage insurance if their LTV ratios are equal to or less than 80%. Non-conforming loans are a subset of conventional loans that possess higher-risk attributes relative to other conventional loans. OSFI expects that FRFIs impose a maximum LTV ratio equal to or less than 65% for such non-conforming loans. It is left to FRFIs to decide which loans are non-conforming, but OSFI notes that this category should include non-income qualifying loans, loans to borrowers with low credit scores, loans with high debt serviceability ratios, loans with underlying property attributes that result in elevated credit risk, and loans that otherwise have clear deficiencies relative to other conforming mortgages. Finally, non-conventional loans are loans with higher LTV ratios that typically require mortgage insurance if their LTV ratio is equal to or greater than 80%.
When determining LTV ratios for various categories of mortgages, FRFIs should assess and adjust for factors that could make the property sensitive to a housing price correction, or that could affect the overall marketability of the property (such as the location, type and expected use of the property, the property's current market price, recent price trends, and housing market conditions), and any other relevant risk factor affecting the sustainability of the value of the property.
These assessment and adjustment procedures do not only apply to mortgage loans. FRFIs underwriting home equity lines of credit (HELOC) should also investigate the sustainability of property values when pricing and determining the LTV ratio for a HELOC. Additionally, OSFI advises that FRFIs should review the approved amount of a HELOC when a material decline in the value of the underlying property has occurred or there is a decline in the borrower's financial condition.
Finally, the draft Guideline B-20 includes an express prohibition of mortgage arrangements (including a mortgage combined with other lending products secured by the same property) that are designed or appear to be designed to circumvent the maximum LTV ratio or other limits established by the FRFI's RMUP, or any other requirements established by law, including co-lending arrangements.