New Canadian Mortgage Rules Hit First Time Buyers Hard
Author: Tracy Ruddell
Thinking of starting a property hunt or are you already viewing houses for sale in Toronto?
If you’re a first time home buyer or a buyer who's not porting an existing mortgage, you need to be prepared for the latest changes to Canada's mortgage application rules. These changes further underscore just how critical it is in this market to get pre-approved for your mortgage before you get too active in your home search.
Earlier this month, the Federal Government announced multiple changes to Canadian mortgages, including a cap on high ratio mortgages and a requirement of buyers to qualify at the Bank of Canada (BoC) posted rate which is much higher than the actual interest rate you're applying for. There are a number of additional changes but, today, we want to focus on the two biggest changes that largely impact first time buyers who don't have a sizeable down payment.
If you know anything about the state of the current GTA real estate market, you'll know that home prices are skyrocketing in just about every city and neighbourhood, bidding wars are more competitive than ever and there's just not enough supply to meet the unprecedented demand that low mortgage rates and record-high rents have created.
What you may not know is that real estate market controls here in Canada are typically left to industry players. Some of these players are government agencies such as the Canadian Mortgage and Housing Corporation (CMHC), a crown corporation who can impose things like mortgage insurance restrictions, and the Real Estate Council of Ontario (RECO), a not-for-profit corporation that regulates the trade of real estate on behalf of the Government of Ontario; others are Realtor® trade associations such as the various real estate boards: the Canadian Real Estate Association (CREA) and the Toronto Real Estate Board (TREB), for example, who put control measures in place to manage things like real estate fraud and phantom bidding that can create artificially-high home prices.
However, the highest levels of Canadian government rarely get involved in real estate industry practices and so these latest Federal-driven changes are quite remarkable. It's important to note though that government in other countries such as Australia and the UK have been involved in things like reporting of foreign transactions for some time and so there is precedent for many of these initiatives elsewhere in the world.
Justin Trudeau's first Ministers' meeting in Vancouver back in March of this year. He visited Vancouver again in June where he met with a panel of experts to discuss housing affordability. Photo courtesy of the Government of British Columbia, licensed under C.C. 3.0 from flickr.
Given that home prices were showing no signs of slowing in Canada's two hottest real estate markets (Vancouver and Toronto), the pressure has been on the Canadian government to instill protective measures. Levels of both municipal governments and the Federal Government have been stepping in to control the real estate market in a number of ways unprecedented here in Canada. For example, the new foreign buyer tax in Vancouver was driven by the BC provincial government and these new changes to mortgage law are imposed by the Fed's.
Here's the "new news" this month.
1. As of November 30, 2016, there will be stricter rules around high ratio mortgages which will:
a) only be available for properties priced under $1M, for a max. 25 year amortization,
b) only available to applicants with a Credit Score of at least 600, and
c) the unit / home must be owner-occupied.
2. Effective as of October 17, 2016, it's now harder to qualify for a mortgage due to more stringent "stress tests" (see below) that require approval at a much higher interest rate, and
3. You must now report the sale of your home (Principal Residence) on your tax return.
On this last point, although real estate profits from selling your Principal Residence remain tax-free, the CRA is trying to crack down on flippers who are avoiding capital gains tax and/or reporting business income (you can be charged income tax versus capital gains if your activities are seen to be in the nature of trade).
In addition to the above changes, the Federal Government is beginning a consultation process to inform a new strategy for reducing risk in the case of a market crash with a high percentage of mortgages in default. Currently, the Government is on the hook for 100% of mortgage defaults which, if it happens in great enough numbers, could obviously have a major impact on the larger economy. This new strategy is assumed to be one of lender risk-sharing.
All mortgage applicants have to undergo what's called a financial "stress test" which essentially means your financial stats are put under the microscope to see how easy or difficult it will be for you to carry your home. This includes not only the cost of your mortgage payments but estimated bills like property tax, utility costs and any other debt that you are carrying (e.g. student loan or car payment).
This stress test is not new (it's always been one of the most critical elements in getting your mortgage application either approved or denied) however the math around it is.
To qualify for a mortgage, you must now qualify not only at the rate that you’re applying for but also for the Bank of Canada's 5-year fixed mortgage rate which is currently 4.64%.
The Bank of Canada posted rate is the average of the big five Canadian banks posted rates but it's an artificial context to a certain extent - in terms of how it impacts an individual's carrying costs I mean - because:
1. People rarely pay posted rates if they have a decent broker negotiating for them (or have a strong knowledge of rates and good negotiating skills themselves), and
2. Even when a big bank won't budge off of their posted rate, there are many smaller lenders and credit unions that will offer lower rates - rates as low as 2.39% for a 5-year fixed rate mortgage and 2.10% for a 5-year variable, as of date of publishing.
That said, we need to be aware of this BoC rate now as it's going to impact everyone who applies for a mortgage moving forward. You can keep track of it here.
Bank of Canada photo © njene from Shutterstock.
While there's always been a benchmark qualifying rate for certain types of mortgage applications that's higher than actual rates, this new rule of qualifying for the BoC's posted rate (which, again, at current rates is roughly double the actual rate you're likely to secure) is going to hit a lot of applicants hard.
This rule is in place for everyone, whether you're applying for a conventional (20%+ down) mortgage or a high ratio mortgage but it's likely to impact first time buyers the most, most of whom are utilizing high ratio mortgages these days.
What's a high ratio mortgage? A high ratio mortgage is any mortgage in Canada where the buyers put down a down payment less than the traditional 20%. You can still buy a home with as little as 5% down for properties up to $500,000 and as little as 10% down for properties between $500,000 and $1M. Homes $1M+ still require a 20% down payment.
If you apply for a high ratio mortgage, one of the caveats (and this is not new) is that you have to pay for mortgage insurance which protects the lender should you ever find yourself in default. There is one public and two private insurers in Canada - the CMHC, a crown corporation, along with Genworth Financial (who were just bought out by a Chinese holdings company) and Canada Guaranty. This insurance premium is added to your monthly or bi-weekly mortgage payment by your lender and so you pay one, blended payment.
These insurers are unlikley to approve you if you are significantly over the CMHC's recommended household debt : income ratio of 39%. Lenders specifically look at two calculations:
Gross Debt Service (GDS): The percentage of your income required to pay all monthly housing bills (mortgage payments, property taxes, utility bills and, if applicable, condo maintenance fees)
Total Debt Service (TDS): The percentage of your income need to cover housing costs (the GDS calculation above) PLUS any and all other debt and monthly obligations you may have such as loans, car payments, insurance payments, credit card debt, etc.
Join us again next time for Part II of our review on the new Canadian mortgage law including the issues that buyers need to keep in mind.
Lead image: Parliament Hill in Ottawa © Wladyslaw / Wikimedia Commons / GFDL.