The Office of the Superintendent of Financial Institutions (OSFI), Canada’s top bank regulating body, has sent a letter to lenders advising them to more closely monitor their lending practices, as risk has increased due to a number of factors.
Household debt and inflated house prices are at record highs, while interest rates are at record lows, meaning borrowers are taking out much more than they can afford. There’s a slight comparison to the US housing crisis—lenders giving out more than borrowers can afford—so OSFI’s advisory letter comes at a good time.
OSFI mentioned a few key points that lenders need to pay greater attention to, changing the ways they are approving borrowers:
While most lenders do verify income, it is a growing trend to not scrutinize a borrower’s income, to ensure they can afford the household debt they’ve applied for.
Lenders also have to do more investigation when a home is owned by a private or numbered company. Income verification in those cases is more difficult, but needs to be done in order to minimize risk.
Debt service ratios
It’s extremely important that homeowners be able to afford the debt they’re saddled with, which includes other debt like student loans, car payments, and credit card debt. Lenders may be conducting the simple debt service ratio calculations, finding borrowers are able to afford a certain price, but not considering that rates can rise and likely will in the future. It’s important to calculate the ratio using higher rates to see how the applicants would do in that scenario.
Especially in hot markets, as with Vancouver real estate and real estate in Toronto, it’s difficult to get an accurate appraisal, as prices are ever-increasing and surging. Appraisals have much to do with the home, but also with recent sales in the area paired with price increases across the city.
Third-party appraisals could inflate the value of a home, so the OSFI encourages that lenders ensure the value of the home is accurate and up-to-date.
Although more of a problem in Vancouver, major cities are seeing suspicious activity and rising numbers of foreign investment in real estate. When funds are coming from overseas, the risk is increased substantially, meaning lenders need to be wary of this type of lending.
OSFI’s letter has no specific weight or implications, therefore it’s up to lenders to determine how serious they believe the situation to be.
Unsplash: Dmitri Popov