Cooling Markets, Addressing Risk, and Reducing Buying Power – New Mortgage Rules
WHAT. On October 3, 2016, Canada’s Finance Minister Bill Morneau announced changes to mortgage rules with the introduction of a “stress test” designed to ensure that home buying borrowers would be able to make their mortgage payments if interest rates were to rise (the “Test”).
HOW. Currently, borrowers are able to negotiate a rate with their lender and qualify for a mortgage loan. For example, today, a lender may agree to lend funds at 2.95% over a five year fixed term (the “Negotiated Rate”). Under the new rules however, the Test requires that in addition to qualifying at the Negotiated Rate borrowers must also qualify at the Bank of Canada’s five-year fixed posted mortgage rate. As of September 28, 2016, the posted rate was 4.64% (which is an average of the posted rates of the big six banks in Canada).
What this means is that although lenders may still be willing to lend at a rate lower than the 4.64% posted rate (for example, 2.95%), the borrower may be prevented from accessing the 2.95% loan if their finances are such that they would not qualify at the 4.64% posted rate. In effect, the buying power of borrowers is being reduced and the federal government is raising interest rates (with respect to housing) without actually raising interest rates.
The Test also requires that home buying borrowers must not be spending more than 39% of income on “home-carrying costs” (e.g. mortgage payments, heat, taxes) and the total debt service (e.g. all other debt payments) for home buying borrowers must not exceed 44% of income.
WHY. The Test allows the Canadian government to achieve a few objectives:
- Attempt to cool high-priced markets in Canada (e.g. Vancouver and Toronto) by pricing out buyers. Canadian housing prices, particularly in markets such as Vancouver and Toronto, are rising at an incredible pace while interest rates have remained at remarkable lows. Under the new rules, prospective purchasers will have a harder time qualifying for loan amounts necessary to allow them to enter hot markets resulting in less demand.
- Reduce the federal government’s financial risk in the event of widespread default of insured mortgages. Currently, the federal government has the financial obligation to cover the cost of CMHC-insured mortgages in the event of a default. As a result, it is in the best interest of the government to take action to avoid mass defaults of government-insured mortgages.
- Encourage more prudent lending and borrowing practices (see objective #2) by preventing home buying borrowers from obtaining mortgages that would be unsustainable in the event that interest rates rise.
WHEN. The new mortgage rules were implemented on October 17, 2016.