Loan-to-income limit

The Office of the Superintendent of Financial Institutions (OSFI) will be implementing a loan-to-income (LTI) limit on the portfolios of federally regulated financial institutions for new uninsured mortgage loans.

The LTI limit will be a simple supervisory measure that will restrict high levels of household debt across each institution’s uninsured mortgage loan portfolio.

• It will serve as a backstop to the Minimum Qualifying Rate (MQR), such as in periods of low interest rates.
• It won’t apply to individual borrowers.
• It will help us advance our mandate of protecting the rights and interests of depositors, policyholders and financial institution creditors.

Background

We published a consultative document in January 2023, to seek feedback on mortgage lending risks, in particular debt serviceability. We published the summary of this feedback and our responses in October 2023.

What we heard

We noted that we regard LTI and Debt-to-income (DTI) as simpler measures that could restrict high levels of household debt at a portfolio level. This mitigates debt serviceability risks by more directly addressing the underlying vulnerability.

OSFI also called out this issue in its semi-annual update to its Annual Risk Outlook. In those publications, we observed that different Canadian lenders have different risk appetites with unique business models in a highly competitive mortgage market. Therefore, a simple, macroprudential LTI measure may not be fit-for-purpose in Canada.

Result

Based on the consultation feedback, OSFI changed its approach to debt serviceability. We’re moving from a uniform, policy-based LTI restriction that would be standard across the industry, to a more nuanced and tailormade approach at an individual FRFI-level. This means that our direction changed from a macroprudential to a microprudential implementation.

Purpose

High household debt is still relevant to credit risk, the safety and soundness of FRFIs, and the overall stability of the financial system. High LTI loans originated during the low interest rate time periods have created a long-term vulnerability to the Canadian financial system. OSFI’s LTI framework will help prevent a similar buildup of loans on books given to highly leveraged and indebted borrowers in the future.

Whereas both debt service ratio limits and the MQR aim to address debt serviceability, this new measure will act as a backstop and provide a simpler preventive measure. This structure will parallel the approach to capital in the Basel III framework.

The LTI limit framework is designed to allow institutions to maintain their same relative competitive positions in the industry. In other words, OSFI’s LTI limit framework is proportionate to the different business models competing for Canadians’ mortgages.

Proposed framework design

The measure will be applicable for new originations at the portfolio level, not for individual borrowers. On a quarterly basis, each institution will need to assess the portion of the newly originated loans that exceed the 4.5x loan to income multiple.

Whereas this 4.5x multiple will be common across all institutions, the portion of the new bookings that will be allowed to exceed this multiple will be unique to each institution and its bespoke competitive model.

Limits

These tailored excess threshold limits will be treated as prescribed supervisory information under the Supervisory Information Regulations.

Limits will be derived using a consistent and principle-based approach. Specifically, the history of high LTI originations trends was assessed at the individual institution level. The framework considers both the period of low interest rates, as well as the more recent origination trends under the higher interest rate environment.

A buffer based on more recent originations will ensure that the limit does not become a binding constraint prematurely.

Scope of loans

To prevent the buildup of leverage by breaking loans into smaller components at different institutions, all loans secured against the subject property are expected to be in scope:

• first and second mortgages, HELOCs, and other borrowing vehicles;
• those held by the same or a different institution;
• regardless of the intended use of the property (owner-occupied or investment property for rent).

Insured loans and renewals are expected to be excluded.

Qualifying income

Total qualifying income based on the institution’s definition should be applied. This should align with the logic used to calculate debt service ratios.

Rationale

This approach will allow institutions to continue competing on a relative basis as they have done in the past.

OSFI has also conducted quantitative modeling exercises to assess different potential frameworks for the development of the limits. However, despite a significant increase in complexity of the approaches, the resulting limits were in-line with this simplified approach.

Implementation

The LTI measure is expected to take effect as of each institution’s respective fiscal Q1, 2025. Once implemented, OSFI will expect quarterly compliance reporting.