Mortgage stress test rules may be pushing borrowers towards unregulated lenders

The Bank of Canada released data this week that shows stricter mortgage rules along with higher interest rates have helped slow the growth of risky mortgages, but some economists question whether over-leveraged borrowers are simply turning to the unregulated mortgage market.

The central bank's analysis said tougher mortgage qualification tests have helped to drastically cut the share of people who borrow at least 4.5 times their annual income to buy a home, and put down small down payments when they do.

Two years ago, that category of borrowers made up 20 per cent of the market. Now it's down to just 6 per cent, the Bank of Canada calculates.

But the central bank's numbers are limited to what's happening at federally regulated institutions such as the country's largest banks. What's happening at unregulated private lenders isn't included. 

Private lenders don't have to comply with federal rules, including Ottawa's tougher mortgage stress tests.

"Areas with high house prices, such as the Greater Toronto Area (GTA), could therefore see more borrowers obtaining mortgages from private lenders because they might not be able to qualify with other lenders," according to the bank's analysis. 

While private lending falls outside of its purview, the central bank admits that it's a part of the market that's growing. For example, the market share for private lenders in the GTA has grown by 50 per cent since last year, and now makes up nearly one out of every 10 borrowers, the bank said.

Unregulated lending isn't inherently risky — but it is difficult for analysts to monitor.

"We are getting into a situation in which the fastest growing segment of the market is the one that is in the dark, and that's suboptimal," said CIBC deputy chief economist Benjamin Tal.

Without more information about what's happening in the private market, Tal said it's unclear whether the central bank's policy changes are simply spreading risk around — as opposed to reducing it. 

"It's definitely lowering the risk in the regulated segment of the market, the question is whether or not it's lowering the risk in the market as a whole," said Tal.

Consumer insolvencies on the horizon

Bankruptcy experts said current data isn't giving a full picture of Canadians' overall debt either.

Consumer insolvencies peaked during the 2007-08 financial crisis and have been relatively stable since 2012. Around 120,000 Canadians went insolvent last year, less than 0.4 per cent of the country's population. But experts in the field know there's a delay between when interest rates go up and when that finally pushes people over the edge.

"Historically, there has been a two year lag from the time interest rates begin to rise and when consumer insolvencies start to increase," said Chantal Gingras, chair of the Canadian Association of Insolvency and Restructuring Professionals.

So far, higher rates are mainly hitting variable rate mortgage holders, but most Canadians who borrow to buy a home opt for a fixed-rate term, which insulates them from rate hikes — for now. When those people renew in an era of higher rates, they could be in for a significant shock.

"At one point," said Gingras, "consumers will hit a wall." 

Still, the Bank of Canada was confident when it hiked interest rates in October that households are adjusting to higher rates and housing market policies.

Based on the central bank's analysis this week, Scotiabank deputy chief economist Brett House said it seems as though the slew of recent policy changes are doing what they were designed to do — but he'd still like to see more data. 

"It doesn't get down as much into the weeds on the impact of the [mortgage] rules as I'd ideally like," said House