The Office of the Superintendent of Financial Institutions (OSFI) announced concern over interest-rate risk last year and has tightened mortgage lending rules as of January 1, 2018.
Property prices climbed in Toronto and Vancouver over the last decade to stratospheric heights, far faster than wages. To cover the gap, Canadians took out massive mortgages at historic low interest rates. Canadian debt stood at a record high 171.1 per cent in December 2017, almost all of it due to mortgages. That means that for every dollar Canadians earn they owe $1.71. It’s one of the highest debt-to-income ratios among industrial nations and earned global admonishment from the Organisation for Economic Co-operation and Development and the International Monetary Fund.
OSFI, Canada’s banking regulator, fears that when interest rates rise, as they inevitably must, Canadians won’t have room in their budgets to pay the increase. That’s on top of other potential individual risk factors that include changes in the borrower’s circumstance, like a job loss or divorce, or a general downturn in the housing market.
Take a million-dollar house, for example. Monthly mortgage payments at 2.99 per cent rate, with a 20 per cent down payment at a 25-year amortization, equal $3,782. Increase that interest rate just 1 percentage point to 3.99 per cent and monthly payments jump to $4,204, or $422 extra per month. That can be challenging for household incomes already stretched by taxes, daycare and rising food costs. At worst, borrowers may default.
To reduce this risk, banks regulated by OSFI must more rigorously assess lending criteria for new mortgages (those up for renewal are exempt).
Borrowers now must qualify at the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate plus 2 per cent, whichever is higher. If a bank was offering 3.5 per cent, for example, buyers would have to qualify at 5.5 per cent.
This is the second change to lending guidelines in as many years, with the federal government instituting a similar stress test in 2016 for mortgages it insures, for those who borrow more than 80 per cent of the value of the property. But now the rules apply even for uninsured borrowers, for those who borrow 80 per cent or less.
In short, income will be stress-tested regardless of the down payment.
OFSI has also banned banks from combining mortgage and lending products to skirt prescribed maximum loan-to-value ratio sand increased the level of income verification.
The income verification guidelines are likely to make it harder for the self-employed (and foreign buyers, who banks previously rarely bothered to verify.)
So is there any hope to obtain mortgage financing in 2018 under these new guidelines?
There is, but borrowers will have to get creative. The best option, obviously, is reducing the amount one has to borrow. So saving up a bigger down payment or hunting for a cheaper property is a top priority. That’s a challenge for Vancouver and Toronto real estate as property prices continue to rise. Buyers are likely to be confronted by unaffordable prices even when driving deep out in the Greater Toronto Area to look at homes for sale in Hamilton, or Mississauga condos. That’s especially true for lower-price options like condos, which saw double-digit year-over-year gains in January 2018, presumably as lower-income buyers rushed to get a foothold in the market late last year before forever being stress-tested out.
The second option is asking for a longer amortization. If a bank allows 35 years to repay, it may reduce the monthly mortgage payments to an acceptable percentage of your income.
The third option is to borrow from a lender not regulated by OSFI. These include credit unions, who are provincially regulated, and individual private lenders who have no regulation.
Non-traditional lenders may still have stress-testing, or other lending criteria, but it’s usually easier to qualify. Private lenders may charge rates up to 10 per cent while credit union’s rates are competitive with the Big 5. Indeed, credit unions pose a stellar alternative to the Big 5.
They have far more flexibility, such as options for 100 per cent financing, longer amortizations, skip payments and prepayment privileges, just to name a few. They also have more innovative products, like mortgages that allow friends to borrow to buy a home together.
Their market share is growing as the internet makes it easier to both find and bank with them, and they work harder to advertise.
Housing analysts anticipate these new rules could disqualify as many as one in five borrowers, slash affordability of the average borrower by up 20 per cent, and drive more business to alternative lenders. It remains to be seen what the full impact of the guidelines will be, though experts expect the full brunt of the changes will be felt by late 2018.
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