New mortgage rules were recently released by Canada’s top regulator of federal banks, The Office of the Superintendent of Financial Institutions (OSFI), and will take effect on January 1, 2018. These rules were designed to protect today’s housing market, and help avoid the economic risks associated with even a slight increase in interest rates. Many of us recall the USA’s financial crises in 2008 when, due to large-scale mortgage defaults, the banks had to be ‘bailed out’. The Bank of Canada and regulators like OSFI have been concerned over Canadians’ high level of household debt, and they hope these new rules help avoid a financial crisis like the US experienced.
The new regulations include:
- Expanded “stress tests” for mortgage applicants to determine if they would be able to make their payments with increased interest rates.
- A ban on “alternative lending arrangements” such as co-lending and bundled mortgages. These practices were often used when people were high-risk applicants.
- Lenders must now follow dynamic loan-to-value (LTV) ratios when approving mortgage amounts for borrowers. This means you have to follow higher LTV requirements if you are buying a home in an ultra-hot neighbourhood where home prices are very inflated.
Why are people getting stressed about the stress test?
The biggest concern or impact of these new regulations is the expanded stress-tests. In Canada, anyone with a down payment less than 20% of the home must get mortgage insurance – which protects the lender if the borrower defaults on the loan. The larger the mortgage amount, the more expensive these insurance premiums are, which is why those applicants currently undergo stress tests. Under the new regulations however, everyone applying for a mortgage will have to pass a stress test to prove they would be able to continue to make their payments if (or when) interest rates go up.
This new stress test will simulate a borrower’s financial situation with either the five-year average posted rate, or, a rate that’s two percent higher than the actual mortgage rate being offered — whichever one is higher. They then would only qualify for the mortgage amount for that higher simulated rate, not the actual current rate.
Let’s look at an example. The mortgage rate comparison website RateHub.ca drafted up a scenario to look at the impact of this new rule on a family earning $100,000, with a 20% down payment on a 3.09% five-year fixed rate (amortized over 25 years). With the existing rules, that family could qualify for a house valued at $706,692. However, once the new rules take effect, they would only qualify for a house worth $559,896 (based on a 4.89% stress test). Finance experts are saying that the average home-buyer will reduce their purchasing power by approximately 20%. Clearly, this could have a significantly impact on the housing market across Canada, especially in larger cities where housing prices are highest.
Additionally, OSFI’s new guidelines state that borrowers who renew their mortgage don’t have to meet the new stress-test standard if they stay on with their same lender. If someone renews with a new lender, they will have to qualify under the new rules because all new financing and paperwork is required. This has some people worried that the banks won’t offer their lowest rate at renewal time; they know that many customers won’t shop around for lower rates because of their fear of not passing the stress test. That’s why it’s always a good idea to talk to a mortgage broker at renewal time or anytime, because it’s our job to shop around for the best interest rates, and we give you solid advice about your mortgage options.
What if I fail the stress test?
If a homebuyer doesn’t pass the new stress test, there are still some good options. They can:
- Improve their application by getting a co-signer who has a solid financial standing
- Put more money towards their down payment to pass the stress test
- Delay buying a home and rent a little longer
- Buy less – such as a condo or townhome
- Visit a broker or credit union to apply – as the new stress-test regulations don’t apply (at the moment) to provincially regulated credit unions
Staying calm in the ‘stress test’ world
There is no need for anyone wanting to purchase a home to give up on their dreams because of this new legislation. The worst-case scenario is that you will have to wait a bit longer to get approved for a mortgage, but the good news is you’ll be saving your hard-earned money in the mean-time – which you can use to invest in your down-payment, reduce debt, or save for a rainy day. Plus, the new stress-test rule just might cool the housing market and lower prices a bit – which we know is great for buyers, but not so great for sellers.
If you are worried about the new stress-test or any of the new regulations, be sure to give me a call. I am an experienced mortgage broker who understands the various rules and regulations, which can be hard to navigate at the best of times! I work with various lenders, which include big banks and credit unions, and it’s my job to source out a great interest rate for you. Call me at 705-230-1306 if you have any questions about mortgages, renewals, or re-financing; I look forward to hearing from you.