Effective Jan. 2018, all Canadians applying for a new mortgage will be subject to a stricter set of rules before approval, including a stress test to assess if they could still make mortgage payments in the event interest rates rise. The new guidelines are published in the Residential Mortgage Underwriting Practices and Procedures document, released this week by the Office of the Superintendent of Financial Institutions Canada (OSFI).
In the past, stress tests were only limited to insured borrowers – meaning those with less than 20% down. Borrowers with less than 20% down are required by law to purchase mortgage insurance, provided usually through the Canada Mortgage and Housing Corporation (CMHC). While the borrower pays the premium – which can add thousands of dollars to the cost of buying a home – the insurance actually protects the lender if the borrower defaults on the loan.
Borrowers who put more than 20% down, on the other hand, do not require mortgage insurance.
Under the new rules, financial institutions will now require both insured and uninsured borrowers to undergo the stress test and qualify at the greater of two options: either the five-year benchmark rate published by the Bank of Canada (currently 4.89%), or the contractual mortgage rate plus two percentage points.
“These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” says OSFI Superintendent Jeremy Rudin in a press statement.
OSFI proposed the changes to the rules back in July. In its press statement, OSFI affirms the new rules are “reflective of risk and are updated as housing markets and the economic environment evolve.”
If your mortgage is coming up for renewal, or if you are planning to refinance or apply for a secure line of credit, these changes won’t affect you if you stay with your current bank.
However, new borrowers should be aware that if they don’t apply before Jan. 2018, they will qualify for a smaller mortgage than they would right now.
In a note sent to reporters, BMO Bank of Montreal Chief Economist Doug Porter tries to put the new OSFI rules into perspective for new borrowers. Practically speaking, he says purchasing power would be reduced by roughly 15% for a potential buyer applying for a maximum mortgage on a $1 million* home with 20% down.
Porter forecasts new home starts will drop by up to 10%, existing sales will fall by up to 5%, and home prices will fall up to 4% due to the new mortgage rules.
Along with increased scrutiny, while assessing loan-to-value (LTV) ratios, there are more new guidelines for lenders as well. All federally regulated financial institutions are now prohibited from arranging mortgages, or a combination of a mortgage and other lending products with another lender in any form that circumvents the institution’s maximum LTV ratio or other limits in its residential mortgage underwriting policy, or any requirements established by law. This will ensure all new homebuyers are subjected to the same stress test rules.
If you’re shopping for a home right now, beware your purchasing power will go down next year. From a personal finance perspective, you should always calculate your affordability at a rate two percentage points higher than what the bank offers you, and pay your mortgage at that rate as well.
If you’re worried you will be unable to buy a home because of the rule changes, chances are you’re stretching yourself financially to the limit already and need to look at homes that are less expensive. Remember, even if the bank offers you a large mortgage, it’s not always financially prudent to take it.
Compare rates at RATESDOTCA and do your research to ensure you're ready to take on what will likely be one of the biggest purchases you'll ever make.
*In the example, BMO used $200,000 down + $800,000 mortgage = $1 million house. The rate was then raised from 3.39% to 5.39%, and the mortgage amount was dropped to equalize the monthly payment. With that, you would actually qualify for a $650,000 mortgage (roughly) + the $200,000 down payment for a maximum of an $850,000 house.