Come Jan. 1, 2018, Canadians getting, renewing or refinancing a mortgage might have to prove that they would be able to cope with interest rates substantially higher than their contract rate.
New rules by Canada’s federal financial regulator announced in October mean that even borrowers with a down payment of 20 per cent or more will now face a stress test, as has been the case since January of 2017, for applicants with smaller down payments who require mortgage insurance.
Ottawa has already moved to tighten the rules around the mortgage market six times since July 2008, with a series of regulatory tweaks aimed at limiting the amount of debt that Canadians and financial institutions take on.
This is the seventh turn of the screw — and it could have a big impact.
Some 10 per cent of Canadians who got an uninsured mortgage between mid-2016 and mid-2017 would not have qualified under the new standards, a recent analysis by the Bank of Canada suggested.
To put a number on it, the rules will likely affect about 100,000 homebuyers, who would qualify for a mortgage for their preferred house today but will likely fail the stress test for an equally large loan next year, according a report published by Mortgage Professionals Canada, an industry group.
Here’s how the new guidelines might affect you:
If you’re planning to buy a house with a downpayment of 20 per cent or more next year
The stress test means that financial institutions will vet your mortgage application by using a minimum qualifying rate equal to the greater of the Bank of Canada’s five-year benchmark rate (currently 4.99 per cent) or their contractual rate plus two percentage points.
If you’re going be house-hunting next year, this may force you to settle for a less expensive home than you would be able to buy today. Or, you might have to wait and save up for a larger down payment.
The rules might force Canadians to set their eyes on homes that are up to 20 per cent cheaper. But since few homebuyers are stretching their finances to the limit when applying for a mortgage, the average target price reduction will likely be smaller, $31,000, or 6.8 per cent, according to Will Dunning, chief economist at Mortgage Professionals Canada.
Of the 100,000 or so prospective home buyers that will hit a snag because of the stress test next year, Dunning estimates that about half will be able to make a different purchase than they had planned. The rest will give up on a home purchase.
If you’re renewing your mortgage next year
Lenders don’t have to apply the stress test to clients renewing an existing mortgage.
This means that if you fail the stress test, you’ll probably get stuck renewing with your current financial institution, without being able to shop around for a better rate.
In some cases, “renewing borrowers may be forced to accept uncompetitive rates from their current lenders,” Dunning noted.
If you’re refinancing your mortgage
If you’re planning on refinancing your mortgage, you’ll have to qualify according to the higher stress-state rates rather than your existing contractual mortgage rate, explained James Laird, president at Toronto-based CanWise Financial.
Say, for example, that you bought a $400,000 home and have a $100,000 mortgage balance left. You’d like to borrow $50,000 more for a renovation. You have a five year fixed-rate mortgage at 3.3 per cent.
Today, your lender would make sure that you can take on a $150,000 loan at 3.3 per cent, said Laird.
Starting next year, your financial institution would have to vet that $150,000 loan using a 5.3 per cent rate. If you’re close to the borrowing limit today, you might have to settle for a smaller loan.
Four cases in which the rules likely won’t affect you
As they generally do, financial regulators have allowed for measures that will ease the transition, making sure the new rules don’t disrupt transactions that are underway by not yet completed in early 2018.
If you sign a purchase agreement on a new home before Jan. 1., lenders won’t have to apply the stress test even if you apply for a mortgage in the new year, said Laird.
This holds for pre-construction sale and purchase agreements, too, he added.
“Usually there’s eventually a cutoff,” said Laird, though in this case it’s not yet clear when that will be.
If you are pre-approved for a mortgage, some lenders will give you 120 days starting Jan. 1 to buy your new home without worrying about the new rules.
The same holds for mortgage refinancing. If you have a mortgage refinance commitment in place by Dec. 31, you have 120 days to follow suit, said Laird.
Of course, the stress test won’t have much of a concrete impact on you if you pass it. Borrowers with plenty of spare financial capacity will be able to go about their business.
About credit unions
The Office of the Superintendent of Financial Institutions (OSFI) rules only apply to federally regulated financial institutions, meaning Canadians might be able to continue borrowing without a stress test if they turn to provincially-regulated credit unions.
In the past, however, credit unions have voluntarily adopted new federal standards on mortgage rates “pretty quickly,” said Laird.
Still, adopting rules on a voluntary basis means they would be able to make some exceptions, he added.
The stress test measures only one of three risk metrics lenders look at, said Laird. Essentially, it ensures that borrowers’ housing expenses compared to their income remain below a certain threshold even if rates rise.
But when evaluating a borrower, financial institutions also look at the size of the loan compared to the price of the house, as well as credit scores.
A credit union that has voluntarily adopted the stress test, might make an exception for a family with very strong credit scores and a down payment considerably higher than 20 per cent, even if they fail to qualify under the new rules by a small margin, said Laird.