Are you Fit for a Mortgage?

What the heck is a Stress Test? Why Should I care?
Starting next year, it will become tougher to qualify for a mortgage.  Earlier this month, Canada’s banking regulator published final guidelines for its mortgage qualification rules.  For some reason it hasn’t gotten as much coverage as other news items, such interest rate hikes or Amazon HQ2.  But it should have because it has serious potential repercussions for the real estate market and the economy.  Today we are going to discuss what you need to know.

Who is making this change?

Canada’s banking regulator, the OSFI (Office of the Superintendent of Financial Institutions).  The OSFI is responsible for supervising and regulating Canada’s financial institutions.

When do the changes come into effect?

January 1, 2018.

What changes are they making to the regulations?

They are tightening standards on uninsured mortgages (mortgages where the borrower is putting down 20% or more of a down payment on the purchase price).  Lenders will soon be required to “stress test” all uninsured mortgages at the greater of: the Bank of Canada’s five year posted interest rate or 200 basis points (2%) higher than the negotiated contract interest rate.

Can you give an example of how this would work?

Let’s say you are looking to purchase a house and are shopping to line up mortgage financing.  Your realtor tells you to go get pre-approved so you understand what price range you can afford.  Your lender offers you a 5 year fixed interest rate of 3.19% (which would be competitive as of the writing of this blog).  Before this change, you were able to qualify at this fixed rate with your lender and based on your ratios you were able to qualify up to a maximum price range.  After the change, you will now have to qualify at the higher of: 4.99% (the bank of Canada’s posted rate as of writing) or 200 basis points higher than the contract rate (3.19% +2.00%) or 5.19%.  In this case you would use 5.19% to qualify.  Naturally with the higher interest rate your ratios would change and your affordability will drop – you won't be able to qualify for as much house!

How will this affect the market?

This will knock some buyers completely out of the market in some higher priced areas and will drop other buyers into lower prices ranges when shopping for a home.  This should increase competition for starter type homes and decrease the pool of buyers in larger and pricier homes.  Other people will be forced to put up a higher down payment (thanks Mom and Dad).  This will also increase rental demand in most markets.

Why are they making this change?

The main reason is to slow down the runaway housing market many cities in Canada have experienced in the last 7-8 years.  The regulator is also concerned about the indebtedness of the population and their ability to handle potential rising interest rates.  This should reign in the mortgage segment at least.

What else should I know?

This applies to you if you are renewing your mortgage as well.  The only time it doesn’t is if you are renewing and staying at the same lender.  But if you decide to switch, you’ll also have to qualify with this new stress test.  It is a bit concerning that some people will be forced to stay with their existing lenders because of this and knowing the borrowers predicament, the lender will not be very generous in their renewal terms.

Of all the changing regulations the government has thrown at the housing market in the last few years, this one has the most potential to really shake things up.  It remains to be seen how the market will respond but it will be interesting to see!  What do you think of these stress tests?  Will they affect your plans in 2018?  We’d love to hear from you.