By now you’ve probably heard on the news that there is another round of mortgage rule changes. These rules will be effective officially on January 1st 2018. Once banks and lenders have had a chance to digest the changes, they’ll roll out what it means in terms of timing. For example, if you purchase a house on November 10th and it doesn’t close until January 15th then which rules apply?
What are the rule changes?
First, none of the rules are a huge surprise because the draft version was communicated earlier this year – see my write up. However, there are actually three rule changes of which two rules are not as interesting. Also, please note that the rule changes are applicable to any federally regulated entity, such as a banks and trust companies. The regulator for these institutions is OSFI (Office of the Superintendent of Financial Institutions).
Rule 1: New Stress Test rate for uninsured mortgages
This stress test rate impacts the maximum amount people can be qualified for – read here for the Debt Servicing Ratios. The new rule impacts any mortgage loan where with more than 20% down payment or 20% in existing equity (these are called conventional mortgages). This new stress test means that borrowers must be qualified at the greater of their mortgage rate + 2% or the 5-year benchmark rate published by the Bank of Canada, which is currently 4.99%. For example, if the actual mortgage rate is 3.39% then the rate qualification rate is 5.39%.
Let’s take an example, an applicant with a $75,000 income that could be approved for $453,827 in mortgage. Under the new stress test rule, the maximum mortgage amount is 20.7% lower at $359,687. This decrease is what people are fussing about.
Rule 2: Lenders will be required to enhance their Loan to Value measurements and limits on their book of mortgages. This is designed to place more emphasis on certain markets that have escalated or declined quickly.
Rule 3: New restrictions will be placed on certain lending arrangements that are designed or appear designed to circumvent LTV limits. In the past, certain regulated lenders could make it appear as though they had a special product that other lenders couldn’t do.
Why were the rule changes were made?
Back in December, I touched the fact that policy are concerned about the levels of debt that Canadians have. These rule changes are another lever they can pull to reign it in.
The world economy was put into a prolonged funk starting in 2008. We saw major countries such as Greece, Ireland, and Italy in desperate peril. Canada, as a commodity based export country, wasn’t immune to the ill effects either. This was made especially true when oil prices declined a few years ago. To help spur the business growth, our central bank - the Bank of Canada – lowered the overnight lending rate to new all-time lows. However, the business growth didn’t rebound as quickly as desired which drove the yields on Government of Canada bonds even lower than historical lows.
As mortgage rates dropped lower, Canadian consumers responded and borrowed more and more debt. This has made policy makers nervous and in particular the debt-to-disposable income has been off the charts. You can read more about it here in a previous write up. The easy access to borrowing spurred the housing market and so now policy makers are concern about housing prices too. Everyone is striving towards stability.
It’s only natural that increasing rates will slow down borrowing, however, the Bank of Canada was handcuffed by an underachieving economy and the inability to raise rates. In response, the policy makers decided that they could achieve the same effect by increasing the rate for qualifying, amongst all the other levers they’ve pulled to date.
For the pundits that are worried about a collapse in the economy, remember that they can quickly reverse mortgage rules if they want. However, don’t expect it to happen any time soon because, as I mentioned before, they are worried about the debt levels of Canadians. I tend to think they’ll come after Lines of Credit next!
Who are the winners and losers?
Time buyers: Loser. It will be harder than ever to qualify for a mortgage. This rule change will also make the Bank of Mom and Dad (see more about BOMAD) less effective because the qualification rates on conventional will be higher than insured.
Mortgage Insurers (i.e. Genworth): Winner. In many cases, it will now be easier to qualify for an insured mortgage because they don’t have to add 2% to the rate. They only have to use the Bank of Canada qualifying rate.
Non-bank lenders: Winners. Banks will now have to qualify at a higher rate (even for simple balance sheet lending) which puts them on a more equal footing with non-bank lenders that rely on insuring and securitizing mortgage loans for funding sources.
Housing market short-term: Winner. I’m thinking we’ll see a rush of activity for people trying to purchase before it gets too difficult.
Housing market long-term: Winner. I believe the change will help provide stability to the Canadian economy as consumers of debt will be brought down to more historical levels. It’s drastic variability that is the enemy of markets, especially housing.
Renewing mortgage clients: Loser. Imagine your existing bank offers to renew you at a higher rate because they know you can’t qualify to move your mortgage anywhere else. Less choice means more bank profits.
Porting or Refinancing mortgage clients: Loser. A simple move from one house to another may not be possible if the new mortgage rules make qualifying for it impossible. They may be forced into….
Private mortgages: Winner. Private mortgages are unregulated and not forced to adhere to debt servicing rules. As more private mortgage investors emerge, we will see lower rates offered too.
Credit Unions: Winner. These institutions are regulated provincially and not by OSFI. Many of their policies adhere to common underwriting policies of the banks. They will either get flooded by applications or start charging more interest rate.
Longer amortization mortgages or shorter terms: Winner. Both of these have the effect of improving the qualifying ratios. When rules change, the market is like spilled water, it flows and finds a way.
Changing mortgage rules is like a spilled glass of water. It finds the path of least resistance. Mortgagors will move into products that results in better approvals, such as longer amortizations, shorter terms, products at credit unions, private funders, insured, etc.
Finally, for those concerned with too much change, keep in mind that mortgage rules can be loosened too. Don’t expect looser rules unless the economy or markets go into a tail spin.
Keep calm and mortgage on.
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage don’t hesitate to contact Ian directly for a free consultation.