What’s the deal with 2018’s new Mortgage rules?

There has been a lot of chatter lately about what the new mortgage rules mean. Let’s set the record straight.

What is a stress test?

The mortgage stress test was put into force by the federal body that regulates chartered banks, OSFI. The rule requires financial institutions to vet your mortgage application by using a minimum qualifying rate equal to the greater of the Bank of Canada’s five-year benchmark rate (currently 5.14 percent) or the contractual rate (the interest rate they offer) plus two percentage points.

What changed?

While the stress test has been around for a number of years, it previously only applied when the down payments were under 20%. With the changes brought in the new year, the stress test now applies to all mortgages, even those with 20%+ down payments.  Let’s take a closer look at these numbers in two examples:

Scenario 1:
In this case, the family’s mortgage rate, plus 2 percentage points, is less than the Bank of Canada five-year benchmark of 4.89%. According to the mortgage affordability calculator, a family with an annual income of $100,000 with a 20% down payment at a five-year fixed mortgage rate of 2.83% amortized over 25 years can currently afford a home worth $726,939. Under new rules, they need to qualify at 4.89%. They can now afford $570,970, a difference of $155,969 (less 21.45%).

Scenario 2:
In this case, the family’s mortgage rate, plus 2 percentage points, is greater than the Bank of Canada five-year benchmark of 4.89%. According to Ratehub.ca’s mortgage affordability calculator, a family with an annual income of $100,000 with a 20% down payment at a five-year fixed mortgage rate of 3.09% amortized over 25 years can currently afford a home worth $706,692. Under new rules, they need to qualify at 5.09%. They can now afford $559,896, a difference of $146,796 (less 20.77%).

Why the change?

Canadians have an enormous amount of household debt. It is presumed that the move is an attempt to decrease or at least slow the growth of debt load in an effort to reduce the amount of risk the finance sector faces. This is a strong indicator that we are going to see further BoC rate increases.

What about Renewals?

Renewals are not subject to the stress test if the mortgagee stays with the same lender. This might however reduce your negotiating power if you’re unlikely to pass the stress test. Since you’d be unable to move to a different lender, you may be forced to accept higher rates.

What if I want to refinance?

Before the changes this year, borrowers only have to qualify at their contract rate. Now you must qualify according to the stress test rules for a refinance. Say for example you bought a $400k home, have $100k owing on a mortgage at 3.3%, and want to borrow an extra $50k for a renovation. Before the changes, you would have to qualify at your contract rate. Now, however, you need to qualify for $150k at 5.3%. If you’re already close to your borrowing limit, you may have to settle for a smaller loan.

What if my deal was firm before 2018?

If your agreement of purchase and sale had all conditions cleared before Jan 1, you can close in 2018 without being subject to the stress test rules
What if I was pre-approved but have not yet found a home?
If you were pre-approved in 2017, you have 120 days after Jan 1 to close before being subject to the new stress test rules

What are industry professionals saying about it?

Robert McLister, founder of intelliMortgage.com, commented that OSFI “hasn’t just ‘tapped the brakes,’ it’s jumped on the brakes with both feet.”

Paul Taylor, President and CEO of Mortgage Professionals Canada, was encouraged by at least one concession that OSFI had made:

"I was pleased that OSFI agreed with our recommendation not to create a prohibition on all co-lending activities and instead clarified that the restrictions only apply to arrangements that are designed to circumvent existing laws or policies ... I am, however, disappointed with the decision to implement a new stress test at whichever is greater of 200 basis points above the contract rate or the benchmark rate. I believe the new qualifying rate will have negative implications for the Canadian mortgage finance market and the national economy as a whole.”

Babujie Arulsubramaniam of Universal Mortgages also believed that the stress test was too heavy-handed:

"As much as the current stress test was intended to help cool the market, the direct impact to the individual home buyer has been extremely crippling.  The reduction in buying power has forced many home buyers, who are dealing with the banks, to either settle for smaller homes, look at other options such as townhomes and condos or even stay out of the market until they aren't limited by these restrictions.  As an alternative option, mortgage seekers are now looking beyond the federally governed financial institutions (the big banks) for more flexible lending options and are choosing to go with mortgage brokers to deal with these financial institutions who are not federally governed and able to legally offer more flexible qualification guidelines. This allows for home buyers to freely purchase the house they truly want that's still within their financial means.  A few notable features that can be obtained by going with a mortgage broker are: extending the amortization period beyond 25 years, getting a larger mortgage by not being subjected to the stress test, allowing for more credit score flexibility that accounts for the one-off financial hardships.

Most solutions that allow for extra flexibility come at a cost and this is where the extra research pays off. Finding the right lender, that allows for the right type of flexibility, will allow for the right balance between getting the exact loan that you need, without overpaying for extra features that you don't need.  Make sure you are being given all the information by asking the right questions to know why you are being offered a specific product. "

 

Can I get around these new rules somehow?

The Office of the Superintendent of Financial Institutions (OSFI) rules only apply to federally regulated financial institutions, meaning Canadians might be able to continue borrowing without a stress test if they turn to provincially-regulated credit unions. A credit union that has voluntarily adopted the stress test, might make an exception for a family with very strong credit scores and a down payment considerably higher than 20 per cent, even if they fail to qualify under the new rules by a small margin.

If a first-time homebuyer doesn’t pass the new stress test, they have three options. They can either put down more money on their down payment to pass the stress test, they can decide not to purchase the home, or they can add a co-signer onto the loan that has income as well.

Bottom line

Avoid nasty surprises in your home search process by getting pre-approved before you start your search.