Recently, the Office of the Superintendent of Financial Institutions (OSFI) has been considering implementing new restrictions on loan-to-income (LTI) and debt-to-income (DTI) ratios in an effort to limit total leverage for households. These changes, if implemented, could have a significant impact on the mortgage industry and borrowers.
Defining LTI and DTI Ratios
First, let's define what LTI and DTI ratios are. The LTI ratio is a measure of a household's debt as a share of their income. For example, if a borrower has an outstanding loan that's 2x their income, then their LTI ratio is 200%. A high LTI ratio, such as 450%, indicates that the borrower is overleveraged or highly indebted, which makes them vulnerable to financial shocks. On the other hand, the DTI ratio is a measure of a household's total debt payments, including mortgages, credit card payments, car loans, and other debts, in relation to their income.
Current LTI Restrictions
Currently, there are no restrictions on the amount of loans that can be made at a high LTI ratio. An analysis by OSFI shows that nearly 1 in 3 mortgage originations in Q3 2022 are to overleveraged borrowers. To address this, OSFI is considering adopting a "high LTI threshold" of 4.5x for mortgages. This would limit the share of these mortgages to 25% of lender originations, which is higher than the pre-pandemic average of 23.8% but still means 8.7% of recent loans would not have been as large as they were in the last reported quarter.
DTI Restrictions
In addition to this, OSFI is also considering debt service coverage restrictions, which would limit a borrower's total debt payments, including mortgages, credit card payments, car loans, and other debts, to a certain percentage of their income. This measure is already in place for insured mortgages, but is not currently applied to uninsured mortgages. This will help ensure that borrowers are not overextending themselves financially and will be able to afford their mortgage payments even if interest rates were to rise.
Revamping the Stress Test
Furthermore, OSFI is also considering revamping the current stress test for mortgage borrowers. Currently, borrowers are tested against a minimum qualifying rate (MQR) to determine how much leverage they can have. However, this one-size-fits-all method has seen many borrowers turn to variable rate mortgages to qualify at a lower rate, which has not always worked out well. OSFI is now considering applying different MQRs based on product risk characteristics to eliminate this risk.
It's important to note that these changes are not yet confirmed and are still under consideration by OSFI. As a mortgage agent, it's important to stay informed and be prepared for any potential changes to the industry
