Mortgage Stress Test: What it means for you and your clients

If the high price of real estate, the lack of inventory or the prospect of higher interest rates didn’t scare us, the news of a so-called ”stress test” for hopeful home buyers sure did.

On January 1, 2018, the Guideline B-20 that is used by federally-regulated mortgage lenders, will require the minimum qualifying rate for uninsured mortgages to be either the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate plus 2% – whichever is greater.

The rationale behind this change is to further guarantee that if interest rates rise, which is expected, home owners will still be able to make their mortgage payments.

These new guidelines mean that even if your clients can get a mortgage for 3.5%, under the new rules they will be assessed as though they are paying 5.5% interest before they get any mortgage at all. This is what Ottawa was referring to as the new “stress test.”

The Superintendent of Financial Institutions (OSFI) announced its revisions to B-20 Guideline for Residential Mortgage Underwriting Practices and Procedures in October, which has led to anxious speculation that up to 20 per cent of people who apply for mortgages with Canadian banks will be turned away next year. Either that or they will be required to lower their expectations substantially for the kind of home they want or need.

The new rules are aimed more at uninsured mortgages which are those with a high (above 80 per cent) loan to value (LTV) ratio.

A loan to value ratio represents the amount of a mortgage lien divided by the appraised value of the property. For example, if your client borrows $92,500 to purchase a home valued at $100,000 their LTV ratio would be 92.5 per cent.  Mortgages with a LTV ratio above 80 per cent need to be insured, and those are the mortgages that will be more difficult to get under the new guidelines.

Here are some of the high level requirements in the new B-20 Guideline:

  • If a buyer was approved for a mortgage already, the new rules won’t affect them.
  • Banks are expected to honour existing pre-approvals issued under the old rules until those pre-approvals expire.
  • Individual lenders can choose which rules to impose on pre-approvals issued between October 17 and December 31, 2017 so it is strongly recommended that borrowers confirm the conditions of pre-approvals with their lenders.
  • Starting January 1, 2018, if a buyer gets a mortgage from a bank, all loan applications or pre-approvals occurring after that date will be subject to the new rules. There are no exceptions, even if the purchase agreement was signed before the new rules were announced.

Because Canadian banks are Federally-Regulated Financial Institutions (FRFI) they are obliged to conform to the B-20 Guideline. And OSFI will audit banks to ensure the Guideline is being followed. Credit unions, mortgage investment corporations, and private lending companies are not subject to the same federal regulations.

Mortgage Professionals Canada is an industry group representing close to 12,000 mortgage brokers, lenders and insurers. In July this year the group published Consumers’ Perspectives on Home buying in Canada. The report indicated the new stress test will mean close to half of Canada’s potential buyers will be subject to the new preapproval terms. When hopeful home buyers were asked what they would do in response, they indicated a few options:

  • 45% would increase their down payment amount
  • 45% would buy a less expensive home than hoped for
  • 20% would buy a home further away than originally intended
  • 39% would delay their purchase

However, the study also noted: “There are multiple factors in play in the housing market at present and it is too soon to draw conclusions on the impacts of the stress test policy.”

Critics of the new mortgage rules have pointed out that instead of dampening the risk from over borrowing, the new guidelines will simply drive people to borrow from private lenders that charge higher rates and come with less friendly terms. If that is true, it could defeat the government’s stated purpose to lower the risks from consumer debt.

As for credit union lending, Samantha Gale, CEO of Mortgage Brokers of BC, says that given credit unions are an alternative source for loans, they could become overwhelmed by the demand and simply run out of funds with which to finance mortgages.

On November 28, BCREA Chief Economist Cameron Muir made the following prediction:

“A rising interest rate environment combined with more stringent mortgage stress tests will reduce household purchasing power and erode housing affordability.”

He continued: “The 5-year qualifying rate is forecast to rise 20 basis points to 5.15 per cent by Q4 2018, and the new qualification rules for conventional mortgages will erode purchasing power by up to 20 per cent. Given the rapid rise in home prices over the past few years, the effect of these factors will likely be magnified.”

On December 14 CREA issued a press release that says British Columbia is projected to record almost 9,000 fewer sales in 2017 due to “an erosion of housing affordability” resulting from tighter mortgage regulations and higher interest rates.  CREA says the average price of a home in BC is forecast to remain steady in 2018.

As with any new government regulations, there will be a period of adjustment as all the players — from the buyers and sellers, to the Realtors and brokers, to the lenders and the lawyers—do what they can to work with the rules and still achieve their goals.

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