Stricter mortgage regulations are coming January 1, 2018. It’s time to think about what that means for you. Back in October of 2016, the federal government implemented new mortgage rules, endearingly known as “stress tests”, that required all insured mortgages to be approved at the Bank of Canada’s posted rate of 4.64%. Now, a similar stress test is coming to non-insured mortgages.
Key things to know (in plain words)
When the new rules kick in, everyone applying for a mortgage will have to prove that they can afford the monthly costs of a 4.89% mortgage – regardless of the rate they are offered and would pay if they are successful.
For example, a couple want to lock in a 2.75% variable rate mortgage. They will have to prove they can afford 4.89%. See below for what that looks like in dollars.
The stress test rate for uninsured mortgages with 20% down payment is either 4.89% or the offered mortgage rate plus 2%, whichever is higher.
Let’s assume that same couple is now being offered a 2.95% rate. They must now prove they can afford a 4.95% monthly payment (2.95%+2%)
Finally, the stress test will apply to new mortgage loans and mortgages that are refinanced or renewed with a different financial institution. If you’re chasing a lower rate in a few years, you might need to pass the stress test to get it.
The stress test will not apply if you’re renewing with the same financial institution.
How will the new stress-tests impact buyers?
According to Canadian real estate blog Better Dwelling, 49% of Toronto households have a median income capable of carrying an average home purchase of $750,800 with a mortgage rate at 2.89%. Under the new 4.89% stress test, that number will drop to 38%.
*Average Toronto home is $750,800
20% down payment = $150,160
Mortgage to carry = $600,640
Rate at 2.89% = $2,497/month
Stress tested at 4.89% = $3,184/month
Average condo price = $558,428
20% down payment = $111,686
Mortgage to carry = $446,742
Rate at 2.89% = $1857/month
Stress tested at 4.89% = $2368/month
The impact on purchasing power will result in a decrease of roughly $150,000 for buyers in Example 1. This means if you’re looking at homes in the $700-800,000 market, you’ll likely have to switch to the $500-600,000 market. The new rules are forcing buyers to build in a buffer on their budget to prepare for future interest rate increases.
Looking at Example 2, a buyer in that situation would need to prove they can pay roughly $511 more each month to qualify for the same mortgage amount. This means the buyer’s annual income would need to increase by roughly $15,000 to qualify. Either you bump up your income, or you look for a more affordable condo you will qualify for at the 4.89% rate.
On the positive side, the stress test is trying to make Canadians more mindful of not maxing out at current income levels.
On the negative end, it’s reducing the current purchasing power. In already hot markets like Toronto and Vancouver, that leaves buyers with fewer options.
Someone who is considering a $500,000 purchase might already be stretching their resources to ‘move up’. The new mortgage stress test will put a ceiling on these buyers and might push them out of the market. This could cool the mid-range, 2-bedroom condo market while warming up more affordable or outlying (not in the downtown core) units where you get more square footage bang for the buck.
Interest rates are likely going up in the next year or two. If they do, the stress test will likely go up with them. In general, this means buyers will be able to afford less, because they won’t pass the stress test.
The stress test could cause buyers to shift markets
Alternatively, we might see the people who cannot afford mortgage carrying costs for a $750,800 freehold purchase shift to the condo market, where they can afford the carrying costs on $558,428. Or, they will seek out alternative lending opportunities from mortgage finance institutions, but the OFSI has made it clear that they are expecting greater fiscal responsibility from all lenders.
Now might be a smart time to move from Condo to Freehold
If you’re a condo owner looking to jump to freehold, now might be the time. You’re selling into a hot condo resale market and buying into a down freehold market. Plus, you’ll beat the stress test and lock in at a low rate. Even if you stretch to get that house, your future renewal would not be stress tested if you stay with the same financial institution.
The stress test hits, prices drop for freeholds because they are costly, but the affordable condo market sees little change. That same condo seller / freehold buyer might see prices drop another 100k and still get in before the BoC bumps rates up again, assuming they have a big deposit.
Why is Canada implementing mortgage stress-tests?
The stress test changes are a precaution as the world moves away from near-zero interest rates. While it’s not the responsibility of the OSFI to cool our overheated real estate, they are plainly concerned about the debt loads of Canadians amid soaring home values. They see the stress test as a brake on overstretched buyers who would be vulnerable as rates rise and who might bring down sensible buyers with them, as was seen in the U.S. in 2008.