In just over 2 months, Canada’s banking regulator launches its controversial mortgage ‘stress test’, probably the most draconian rule change in recent history, aimed at people with heavier debt loads and at least 20 per cent equity.
This past week, the Office of Superintendent of Financial Institutions (OSFI) – Canada’s banking watchdog – introduced tougher mortgage rules that will take effect January 1, 2018. This new ‘stress test’ applies to homebuyers with down payments greater than 20 percent and requires the mortgage applicant to qualify for the higher of the Bank of Canada 5-year qualifying rate or the mortgage-holder’s contracted rate + 2 percent.
The concept of a mortgage stress test was introduced in fall 2016, aimed at buyers putting down less than 20 percent to ensure they could qualify at the lender’s 5-year posted rate. Uninsured mortgages (typically those with more than 20 per cent down payment) were not included at that time, based on the assumption that those putting more money down should be more able to manage the debt load.
This latter does not take into account all the down payments that have been gifted to first-time homebuyers by family. A first time buyer could purchase a $400,000 home with an $80,000 down payment as a gifted amount and still be able to qualify for a $320,000 mortgage that in the cold light of day would probably be unaffordable.
Do the new rules apply to existing homeowners? The short answer is no, you won’t have to re-qualify at the higher rates when you renew your mortgage if you stay with your existing lender and if you have no missed payments (e.g. NSF cheques, or property tax delinquencies)
Today, uninsured borrowers can qualify for a mortgage at five-year fixed rates as low as 2.97 per cent, or a variable for prime -0.8 (2.4%). In a few months that fixed rate will soar to almost 5 per cent. In which case, buyers may require as much as 20 per cent more income to get the same mortgage a homebuyer could get today. Many borrowers will be forced to abandon the hope of home ownership, or pay higher rates, find a co-signer and/or have a bigger down payment to qualify for a mortgage.
Many homebuyers with above-average debt, relative to income, will more than likely have to resort to much higher-cost lenders who allow more flexible debt ratio limits. At the very least, more will choose longer amortizations (i.e., 30 years instead of 25 years) and take longer to pay down their mortgage. Non-prime lenders will also become pickier. Why? Because they will see a flood of formerly “bankable” borrowers being declined by the Big Six. That could force hundreds of thousands of borrowers to borrow from lenders with the highest rates. So having a higher debt load, weak credit and/or less provable income will prove difficult. The shift to expensive non-prime lenders will increase mortgage carrying-costs and put many higher-risk borrowers into a debt and default risk.
Some possible outcomes:
• A bonanza for non-prime lenders. Non-prime lenders and credit unions, mostly not under OSFI, will fund mortgages based on an actual (contract) rate, instead of the much higher stress-test rate.
• Banks are thrilled about customer retention. If your bank knows you cannot leave, you know they will use that as advantage to raise rates to subpar levels.
• Panic buying in the near term from people afraid of not qualifying after January 1. This could slow down the housing market.
• The stress test could push prospective homebuyers away from banks to lenders that are not federally regulated.
• A possible slow-down in skyrocketing house prices in some areas of Canada, particularly Vancouver and Toronto.