Canada’s new mortgage rules: Will they affect affordability?
- In late 2016, Canada’s new mortgage rules – aimed at promoting responsible home ownership – were introduced by the federal government. Although the changes included measures geared toward curbing foreign real estate speculation and others specific to low loan-to-value mortgages, let’s focus on the change most likely to affect affordability for you, a first-time home buyer purchasing with less than 20% down: the stress test.
The affordability of Home ownership has been helped in recent years by low interest rates and the availability of high loan-to-value mortgages backed by mortgage insurance. But what would happen if those interest rates were to jump? Concerned by that scenario, the government introduced tougher stress-test criteria in fall 2016, with the aim of reducing mortgage default among home buyers. What does that mean for you? More likely than not, less money to work with. Here’s why.
Changes to the stress test
Two big changes to stress-test criteria have had an immediate effect on affordability.
NO. 1: THE NEW BANK OF CANADA INTEREST RATE BENCHMARK REDUCES THE AMOUNT OF MORTGAGE YOU QUALIFY FOR
While you may qualify for a fantastic five-year fixed mortgage rate from your bank (2.94%, for example), the new rules use the Bank of Canada’s five-year fixed mortgage rate (4.64% in late 2016, for example) to determine whether you can afford your mortgage payments.
This tougher affordability standard was put into place to ensure you can still afford to make your mortgage payments were rates to rise dramatically.
RESULT: The new rules say you can afford less house for your income – approximately a 20% to 30% reduction in the mortgage amount you qualify for.
Did you know that you can qualify for a mortgage sooner with a lower down payment by using mortgage insurance?
No. 2: The Bank of Canada interest rate extends to debt service ratios
Lenders and mortgage insurers look at two debt service ratios when qualifying you for a mortgage and mortgage insurance.
Gross debt service (GDS)
The carrying costs of your home, such as mortgage payments, taxes, heating, etc., relative to your income.
Total debt service (TDS)
Your home carrying costs (mortgage payments, taxes, heating, etc.) plus your debt payments (credit cards, student loans, car loans, etc.), again relative to your income.
To qualify for mortgage insurance, the highest allowable GDS ratio is 39% and the highest allowable TDS ratio is 44%.
Here’s the tricky part: when calculating the GDS and TDS ratios, the new rules indicate that lenders and insurers must assess your hypothetical carrying costs using the higher, Bank of Canada interest rate. That means many buyers who would have squeaked through under the old rules, will push past the 39% and 44% thresholds using this higher Bank of Canada rate.
RESULT: Higher carrying costs (as assessed under the new stress-test criteria) will make it harder for first-time home buyers with less than 20% down to qualify for a mortgage.
What can you do?
- Canada’s new mortgage rules, while controversial, are here in force. And the good news is, working within them is possible! You may have to revise your plans or timelines, but first-time homebuyers can still get into the real estate market.
- Get yourself on track to buy your first home by laying the groundwork for responsible home ownership: reduce your consumer debt, save for a larger down payment, and boost your overall financial fitness.