For the second time in as many years, a major change has been announced in the way people qualify for a mortgage. Last year, the change only impacted buyers who were putting less than 20% down. This time it impacts not just would be buyers, but also those who already own their home and will be renewing their mortgage as well, and the ripple effect could be staggering! Let’s examine the change, and five potential ripple effects that we should anticipate.
The Change: On October 17, 2017, the Office of the Superintendent of Financial Institutions (OSFI) announced changes to its mortgage underwriting standards (Guideline B-20), to take affect January 1, 2018. Under the new guideline, borrower with uninsured mortgages will need to prove that they can afford payments based on the greater of the Bank of Canada’s five-year benchmark rate (currently 4.89%) or their contract mortgage rate plus two percentage points. While it does say that renewing borrowers who stay with their current lender do not have to qualify against the new guidelines, it’s possible that you may have to if you wish to switch lenders to get a better rate.
Potential Impact #1
A surge in housing prices and bidding wars.
Anyone who is putting 20% or more down when purchasing a house will now qualify for a house that is 17-20% lower in value. If they were in line to purchase a home for $500,000, they will now only qualify for something around the $430,000 range. In major markets, that is likely to drive home buyers to nearby “more affordable” cities causing an influx in competition, and an increase in “over asking price” offers. These are pretty much the types of things the rules were meant to put a damper on.
Potential Impact #2
People are no longer able to ‘move up’ to that bigger house.
I’ll give an example of this potential impact. A couple just starting a family four years ago bought a small home for $279,900. Now they have a couple kids and need a bigger house. Their income and debt ratios, under the current rules, would allow them to afford a house that is $500,000. With the new stress test, that amount becomes $430,000. Due to the surge in values in the last few year, a house that is currently worth $430,000 isn’t going to be that much bigger than the place they bought at $279,900 four years ago. So why take on the extra debt, when you could renovate and make due?
Potential Impact #3
People will not be able to consolidate debt.
The true issue facing us isn’t mortgage debt, its household debt. I’ve never understood the practice of telling someone they can only afford a mortgage for “X” but, once they have it, then offering them lines of credit, credit cards, etc. It’s been common practice to consolidate these debts into your mortgage at the time of renewal (or earlier depending on your situation). With the new benchmark rate, many may not be able to afford the debt level if they try to do this. This could force many to just sign a renewal notice with their current lender and struggle with the high interest debt or be forced into consumer proposals. Which leads to our next potential impact.
Potential Impact #4
Renewal rates could jump significantly.
As of right now, people who renew with their current lender will be exempt from the new stress test, so long as it is a straight renewal. Refinancing or switching lenders may require the borrower to requalify. This will cause many to simply renew with their current lender, and not allow them to take advantage of potentially better rates elsewhere. Knowing that many of their borrowers have no choice but to renew could cause the lenders to offer higher rates at renewal time. This, combined with rising rates, could result in a significant jump in the borrower’s mortgage rate.
As an example, a borrower who bought a $300,000 house on a 5-year fixed rate of 2.69% with 5% down had a payment of $1356. At renewal time, the balance would be $251,820. A lender could offer a renewal of a 5-year fixed rate of 5%, amortized over 30 years, and the payment would be $1344. They know the borrower can afford it because its lower than their current payment. However, at the end of the 5 year, the balance would be $231,074. The borrower will have paid almost $20,000 more in interest over the 5 years.
Potential Impact #5
Investors Switch to Private Mortgages
Investors who are carrying a few rental properties may not be able to add to their portfolio under the new stress test. The smartest solution would be for them to switch a few of their properties into a private mortgage. The interest rates may be a bit higher but, because it is an investment property, they can write the interest off on their taxes and use that tax break to pay down the principal. It’s a strategy that has gained a lot of traction in the last six months and will become much more prevalent with the changes on January 1st.
Ultimately, as with any changes like this, we can only anticipate the ripple effects. We won’t truly know the scope of the impact until we see it play out. But unlike the changes in 2016, this one certainly affects nearly everyone in the housing market.
If you have any questions, please feel free to reach out and I will be happy to discuss it with you.