New “Stress-Test” 2017 / 2018 Mortgage Rules Changes Explained
Recently as you have probably heard in the major news media, like Global News and CBC, late in 2016, new rules were announced by OSFI with respect to residential home mortgages. The decisions leading up to these new rules are primarily driven by ‘expert’ concerns about rising home prices in a few Canadian markets Vancouver, and Toronto. Prices in Victoria, BC are up significantly as well but our demand continues to outstrip supply even after the first wave of new rules have been implemented. The thinking behind making it more difficult for Canadians to buy and refinance is that it might calm down the housing market, and specifically limit price increases.
I’m not going to get into it too deeply here but the thinking behind these new rules is counter-intuitive, and possibly quite damaging to Canadian families and the Canadian economy in general over the long term. The summary of my thinking here is as follows:
These new rules essentially force many well-qualified would-be home buyers to rent for an extended period of time. This includes first-time home buyers and new Canadians. By forcing these people with great credit and hard-earned savings to rent, you are adding fuel to an already extremely hot rental market. In Victoria BC we see the rental vacancy rate hover around 0% and anyone will tell you that the rental market here is basically ‘impossible’.
So what right? So people who can afford to buy have to rent for another year or two. What’s the big deal?
Well think about it this way…
1. This drives up rental demand, which drives up rental prices, which drives up the prices of residential homes, aka Economic 101. So in effect these rules may delay home ownership for many Canadian with no guarantee that home prices will come down.
2. If this proves to be true, and wealthy investors, both foreign and domestic see no end in sight to incredible returns on their investments (ROI), then when will home prices come down? Never. And will the incomes of these sidelined buyers rise fast enough to allow them to catch up to the increasing home prices? This remains to be seen.
But what if the answer is no. What if people decide to give up on home ownership and instead make renting their normal lifestyle, as in many parts of the world. How do we fix that? How do you get the toothpaste back in the tube? I didn’t see that addressed in the new rules policy statements.
Ok – enough expert opinion now the Facts: What is the Stress Test as it pertains to you?
To put it simply: the stress test is used for approving new mortgages in an attempt to ensure that the homeowner can still afford their mortgage should the interest rates increase significantly .
For the majority of lenders you must still meet all the standard mortgage lending criteria that includes down payment, steady and provable income and good credit.
*** But now if you are approved for a 2.99% mortgage you must qualify at 4.99%. ***
So what does that mean? Well the primary test for affordability is called ‘Debt Service’ essentially meaning the ratio of the debt you’ll carry when you own your home, versus the income you receive. For the purposes of clarity let’s forget about all the other debt you may have; student loans, car payments, etc. which all fall under TDS, or Total Debt Service. I’ll cover that in another blog post. TDS can be up to 44% for reference.
In round numbers:
1/ Assume you earn $100,000 per year gross income as totaled from all qualified borrowers on the mortgage
2/ Assume you are qualified (credit, etc) to carry a “Gross Debt Service” or GDS of 39%
RESULT: That means the total MAXIMUM annual home expense (including mortgage payments, condo fees, property taxes, heat) would be $39,000. This isn’t new, and it makes good sense.
What IS new is that, in effect, OSFI has raised you mortgage payment (not in reality but for the purposes of qualification for the mortgage) by requiring lenders to qualify you at an interest rate 2% higher than you will actually pay!
So what does that mean in reality:
On a $400,000 mortgage at 2.99% your payment is $1891. Your actual payment.
But a $400,000 mortgage at 4.99% this makes your payment ‘appear to be’ $2324.
So basically you can borrow less. As it turns out you can borrow far less. And in Victoria, BC where I live it turns out that a family making $80,000 a year, with great credit – CAN’T Buy A House (unless they have a massive down payment or they want to live 2 hours away…).
This has actually been in effect for a several months now but ONLY for borrowers with LESS that 20% Down Payment. Those borrowers that need CMHC, Genworth or Canada Guarantee Mortgage Default Insurance.
The New Version of the Stress Test is definitely more stressful as it impacts every borrower, no matter how much they have for down payment. So even if you were once considered a ‘conventional mortgage borrower’ with more than 20% down as a purchaser you now have to meet the stress test.
And in the case of refinance of renewal even though you have 20% equity in your home you’ll have to meet the new stress test rules. For borrowers looking to renew their mortgage this will definitely impact your ability to switch lenders to get a lower rate.
The effects in the mortgage market continue to unfold. What we know for sure is that many lenders are considering ‘risk based’ pricing (aka higher rates for different situations). For example we have lenders that will stretch your amortization to 30 or even 35 years. So with 20% down or more you could increase your buying power by taking on a longer amortization period, and most likely paying a slightly higher rate.