Canadian financial regulators announced their seventh rule update since July 2008 to tighten mortgage rules. Announced last October and effective since January 1st, 2018, this new "stress test" will make sure that homeowners can afford the house that they’re looking to buy and also, hopefully, cool the Toronto and Vancouver housing markets.
This stress test is designed to see if the borrower can pay back their loan at a higher rate than they actually have to, thus, accounting for potential interest rate hikes. As well, it will prove that the borrower can continue to meet mortgage payment obligations in times of personal financial turmoil, such as job loss.
Toronto Mortgage Advisor Darlene Hanley of the Hanley Mortgage Group thinks the stress is a good idea:
The consequence of not putting in a stress test is that in the event of a recession we could have a collapse of the real estate market. Ultimately what we want is a stable reliable market with low price volatility where people can buy and maintain their homes with confidence. These [new mortgage rules] create a foundation for that environment.
The new criteria for uninsured mortgages, under the 2018 mortgage rules, include a qualifying rate equal to the Bank of Canada’s five-year benchmark (5.14 per cent as of March 2018) or the borrower’s contract rate plus 2 per cent—whichever number is higher.
For insured mortgages, the qualifying rate is the greater of the Bank of Canada’s five-year benchmark and the borrower’s contract rate. Additionally, secured line of credits are qualified with either the line of credit’s contract rate plus 2 per cent or the Bank of Canada’s five-year rate—again, depending on which is greater.
For example, if Sally had an uninsured mortgage at a rate of 3.3 per cent and the Bank of Canada’s five-year benchmark sat at 5.14 per cent, then Sally’s qualifying rate would be 5.3 per cent (her mortgage rate of 3.3 per cent plus 2 per cent). Additionally, if Sally’s looking to purchase a $500,000 property with her 3.3 per cent mortgage rate, a five-year fixed closed term, and a 25-year amortization, she’ll have a monthly payment of $1,960; however, Sally needs to prove that she can make monthly payments at 5.3 per cent or $2,409 to get approved.
On the other hand, if Fred had an insured mortgage at a rate of 3.3% and the five-year benchmark was 5.14 per cent, Fred’s qualifying rate would be 5.14 per cent because the five-year benchmark is greater than his mortgage rate.
Who will and who won’t be affected
Anyone securing a mortgage after January 1st, 2018 will fall under the new rules. Additionally, borrowers looking to refinance or to change lenders will also need to qualify under the new criteria. So, if a homeowner is looking to borrow against their property for renovations or has found a better rate at a different lender, they will have a harder time making such an action due to a higher qualifying rate.
In contrast, individuals who bought a pre-construction condo, secured their mortgage before January, 1st or are renewing a mortgage will qualify under the old rules. Alternative lenders, such as credit unions, are also not required to follow new qualifying rates but can voluntarily do so; however, these lenders tend to charge much higher interest rates. Lastly, in the scenario that someone had a pre-approved mortgage before Jan 1st, lenders, at their own discretion, can provide a 120-day window (starting January, 1st, 2018) for the borrower to buy a home under the old rules.
The mortgage rule changes will primarily affect those with uninsured mortgages—homebuyers paying a down payment of at least 20 per cent of their property value and, thus, aren’t required to buy mortgage insurance. Individuals with insured mortgages have already been undergoing another stress test which came into effect in 2016. Therefore, people in the market who are looking to switch to a more expensive home or who can afford a 20 per cent down may have a harder time than before searching for a new mortgage.
Overall, these changes are expected to affect over 100,000 Canadians, according to a report by Mortgage Professionals Canada. Many buyers will have to adjust to buying a smaller home or renting for a while longer.
Richard Silver, Senior Vice President-Sales at Sotheby's canada says the new rules had a cooling effect on the market, as expected:
The new mortgage rules are affecting the buying power and borrowing power of all Canadians and has had a chilling effect on the market for those hoping to make substantial movements up in housing. Sadly it affects those that really need the assistance that mortgages can provide. Young families are probably the hardest hit and [the new rules] will also make stay-at-home parents head back to the workforce sooner.
To the Canadian economy, however, Darlene Hanley doesn’t believe much will change:
There is still a need for housing. All this will do is change the levels of affordability for given types of homes. Ultimately it shouldn’t make any difference [to the economy].
Tips for obtaining a mortgage in 2018
Paying off your debt
Any debt that a potential homebuyer carries can affect the mortgage that they qualify for. Eliminating outstanding loans or outstanding credit card debt can help a homebuyer find the best mortgage arrangement.
Avoid big purchases
Similar to paying off debts, bringing in new debt while looking for a mortgage is not the best idea. Lenders typically re-check a borrower’s credit before closing, and any new debt could prevent an approval. While a $4,000 vacation may seem like a great idea, it can wait till after the mortgage is approved.
Stick to your job
Lenders need to know that you have a secure source of income to make monthly mortgage payments. While quitting a job one hates may seem like a great idea, proving a reliable and secure income is crucial to getting approved.
Keep within your means
The new 2018 mortgage rules will reduce purchasing power for many homebuyers, but this may be for the better. Just because a lender approves a million-dollar mortgage, it doesn’t necessarily mean the borrower can afford it. Approval amounts are based on income and credit reports and do not usually factor in personal expenses.