Getting approved for a mortgage will get trickier thanks to proposed stress test changes from our banking regulator. But if you’re a mortgage shopper fretting tougher borrowing rules, don’t.
The Office of the Superintendent of Financial Institutions (OSFI) proposes raising the interest rate that people must prove they can afford by 0.46 of a percentage point. The so-called minimum “stress test rate” at federally regulated lenders would effectively go from 4.79 per cent today to 5.25 per cent on June 1, assuming rates don’t change by then.
To call that a major clampdown would be exaggerating. In fact, if this is all the government did to cool mortgages, lenders will do cartwheels.
If you’re a mortgage shopper, here’s what the new Canadian mortgage stress test rules actually means.
You probably won’t feel it (much)
OSFI’s move might push one in 10 uninsured mortgage borrowers over the standard 44 per cent “total debt service,” or TDS, ratio limit. Banks want you under that limit to ensure you’re not overleveraged.
But the move has no effect if you simply renew with your existing lender. That said, folks with higher debt ratios might get less attractive renewal offers if banks think they’re less likely to switch lenders. OSFI plays down this but mortgage professionals see it in practice all the time.
It also won’t affect you if you’re buying with less than 20 per cent down, which more than one out of five bank borrowers do. That’s because the stress test on default insured mortgages isn’t changing – at least for now.
If you’re on the edge, watch out
According to my calculations, the stress test will cut buying power just over 4 per cent for those making down payments of 20 per cent or more, with a 30-year amortization and $100,000 annual income. In other words, if you can afford a maximum $500,000 home today, you’d only be able to afford a roughly $479,000 home come June 1.
While it would only raise TDS ratios by about 1.5 percentage points, if you’re living on the edge financially, that’s enough to limit home options. It could also reduce the amount of money you’d get in a refinance, or lower your credit limit on a home equity line of credit (HELOC).
If you’re out there home buying and pushing your debt ratio limits (not recommended), you can always get preapproved before the changes take effect. Just be sure the lender agrees to honour its preapproval amount after June 1.
An OSFI spokesperson also provided an important clarification Friday: “If a mortgage is preapproved before June 1 the new minimum qualifying rate does not apply, even if the sale doesn’t close until after June 1. However, there must also be a signed purchase and sale agreement.”
There are workarounds
Those affected by this change have plenty of options, among them:
- Putting more money down – this lowers your debt ratio.
- Buying a cheaper home – OSFI may inadvertently be accelerating the urban flight.
- Extending the amortization – thus lowering your payments, which makes it easier to get approved.
- Buying with a co-borrower – adding more income on a mortgage application lowers your debt ratio, again making it easier to qualify.
- Using a non-federally regulated lender – some credit unions and alternative lenders don’t use the federal stress test, albeit their interest rates are higher.
- Reverse mortgage – more seniors who are cash strapped but equity rich could turn from traditional financing to reverse mortgages, which are not stress tested.
It could exacerbate economic cycles
The government is now in the market-timing business. That might be a problem if OSFI adjusts the stress test floor only once a year, as it indicated it may. A delayed adjustment to the stress test floor could retard housing growth when rates dive (that is, when a weakening economy needs stimulus the most) and fuel housing growth as rates climb (when the opposite is true).
This isn’t 2018
When OSFI rolled out the original stress test a few years ago, that was a big deal. It slashed maximum potential mortgage amounts by more than 18 per cent.
This tweak is different. Low rates, strengthening employment, heaps of federal stimulus, record-low housing inventories, expectations of rising home prices and stress test workarounds will ensure the slightly higher qualifying rate has a limited impact. It’s more of a housing buzz-killer than an actual demand killer. And it’s in no way a reason to bolt out and overpay for a home before the implementation deadline.
Most likely, the government isn’t done. Additional housing restrictions are probably on their way later this year, and other things equal, demand curbs are rarely a near-term positive for home prices.
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