We’ve been getting a lot of clients asking about the new mortgage stress test and what it actually means, so we decided to turn to one of our most trusted experts in the industry to share some insights on what’s really happening. Also, what it means for you as your look to purchase a new house or condo.
With over 20 years of experience, Deren Hasip has helped many clients understand real estate financing and achieve their goals in the Toronto market. We trust him and so do our clients. Here are his insights on the much-buzzed-about stress test and what it means for your real estate future.
New Stress Test: What you need to know?
Unprecedented growth in the Canadian housing market has made a potential housing bubble a popular topic that dominates today’s conversations. Despite the fact that a housing market crash is highly unlikely, the government still has a fiduciary responsibility to protect new homeowners and the economic fundamentals that helped Canadians survive the 2008 US market correction, unscathed. That responsibility rests with the Office of the Superintendent of Financial Institutions (OSFI). One of OSFI’s core mandates is to oversee the regulatory environment assessing risk and proactively implementing early interventions and corrective measures. Although their decisions may not be popular, they are indeed necessary.
In order to understand the new proposed changes, you’ll need a crash course on the current landscape. In the market today, there are three types of mortgages as it related to default insurance:
The owner or non-rent paying family occupied residences where the customer has purchased a home with less than 20% down, secured default insurance at their own cost, and transacted at a price point of less than $1,000,000. These mortgages are stress-tested with a maximum amortization of 25 years.
An insurable mortgage is where a mortgage is qualified based on the insured mortgage guidelines however, the cost of the default insurance is paid for by the lender. The lender chooses to do so in order to back-end insure the mortgage to increase its marketability in raising new capital for lending.
An uninsured mortgage is one where default insurance can not be secured and is often funded off of the balance sheet of the lender. These mortgages are:
- In excess of $1,000,000
- Can be non-owner occupied
- Have amortization in excess of 25 years
- Can accommodate refinances
- Can only finance up to a maximum of 80% of the property’s value
Over the course of the last 10 years, the Department of Finance and OSFI have introduced many measures to allow for Canadian financial institutions to continue to put homeownership within the grasp of Canadians resulting in 68.5% achieving homeownership. The majority of these changes were directed at default insured clients, the segment of consumers that represented the highest risk. These changes, often perceived as losses, weeded out marginal buyers by imposing:
- Higher down payment requirements increasing the buyers stake in the purchase
- Shorter amortization allowing to shorten the risk exposure
- Introduction and fine-tuning of the Stress Test to ensure that each buyer had the financial resources to handle higher payments at renewal by qualifying based on a higher standardized rate
- Elimination of the default insured refinance program to make sure that Canadian consumers still maintained adequate equity in their home
To minimize speculative activity:
- They increased the minimum down payment for rentals to 20%
- Limit the number of default insured mortgages per consumer
- The introduction of such measures increased the barrier for entry into homeownership and discouraged speculative buyers. Let’s put this into perspective:
A first-time buyer who purchases a new home with 5% on a $500,000 purchase will need a mortgage of $475,000. The default insurance cost at that level is 4% which equates to $19,000. This amount is added onto the mortgage which increases the total mortgage amount to $494,000. That means the day this customer moves into this home, their equity will be worth $6,000. If the market were to correct by 10%, the real estate value would be worth $450,000 and the customer would be in a negative equity position.
Someone is far more likely to consider insolvency measures such as consumer proposals and bankruptcy if they’ve got no equity to remain financially vested in the transaction.
As you can see in this illustration, the default insurers have the most to lose in a market correction which is likely why CMHC in spring of 2020 predicted a large market correction of 10-18% over the course of the next 12 months. Those with the least amount of equity represented the greatest risk. Therefore, by sharing a pessimistic outlook, would deter marginal buyers from transacting.
Given the expensive cost of default insurance and more stringent lending guidelines, if today’s consumer is looking to retain their equity and stretch their purchasing power they would need to solve for the 20% down payment. This is where the bank of mom-and-dad has enabled today’s consumers, most notably millennials in securing homeownership outside the confines of default insurance.
And this now brings us to the new proposed changes and the mortgage stress test that are being tabled for June 1st, a new higher minimum qualifying guidelines for uninsured mortgages. This new guideline that will apply to all uninsured mortgages will mean that anyone that fits within these parameters will be qualifying based on the higher of the contract rate plus 2% or a new benchmark rate of 5.25%.
The table noted below illustrates an example for an average household earning $100,000 in annual income. In this particular case, a move from the current benchmark rate of 4.79% to the higher new proposed rate of 5.25% will result in a loss of $22,259 (4.4%) in purchasing power for customers who are looking to consider uninsured mortgage solutions.
Should the new mortgage stress test change put your dream home just outside your reach, it’s important to note that not all lenders are federally regulated. Credit unions are provincially regulated and fall outside of federal governance. A select number of credit unions continue to offer solutions based on contract rates to help stretch your purchasing power, but important to note that they do so for a rate premium.
To learn more about how the new mortgage stress test affects you personally and explore all available options, feel free to reach out to TRB by filling out the form below or visiting Deren’s website – Mortgage Scouts.