New Mortgage Rules Canada

There is a great deal of concern and talk about Canada's New Mortgage Rules and the impact on Buyers, Sellers, the Real Estate Market and Canada’s economy. These measures have been put in place to ensure home Buyers are fiscally responsible in purchasing what they can really afford and don’t take on a debt burden they can’t handle - not just today, but for the future.  And in doing this, keep Canada’s interest rate as low as possible for as long as possible.

Home ownership is ‘the dream come true’ and the biggest investment anyone is likely to make. I always advise my Clients that this is a ‘Life Style’ decision not just a Real Estate one. There are many financial considerations to take into account: taxes, utilities, home maintenance, plus life expenses such as vacations, entertainment, and (if applicable) children’s extra curricular activities etc.

The Toronto market values and sale prices are at an all time high. A single detached home in Toronto is averaging $1,120,000 and a semi-detached/townhouse is close behind.  Even in the surrounding GTA areas, prices are up to $900,000 and above. 

The first time Buyers I, traditionally, work with are looking to (and know they have to) spend $1,000,000+ and, right now in the city’s core, plus Thornhill, Markham, Richmond Hill and Woodbridge, finding a livable home for less than $1million is like looking for a needle in the proverbial haystack.  

There is a lack of sales inventory and Buyer demand is huge. Homes are listed very low and everywhere in the GTA now, multiple offers are being requested on a specific date. With Sellers being open to a ‘Pre-emptive or Bully Offer” at any time, some of these homes sell at huge prices within an hour of being posted on MLS. But the bidding wars prevail and propel the sold prices astronomically beyond the listing price. But I will continue to say that pricing a home at $899,000 when any knowledgeable Realtor knows the value is actually $1,500,000 is just the same as if the Seller put a $10.00 price tag on it. 

The result: - home prices are so expensive they’re out of reach for most. Unless:

1. Buyers already have equity in their homes which they are selling
2. Buyers stretch themselves too thin financially and aren’t thinking about what could happen when future interest rates go up, which eventually they will.
3. Buyers readjust their lifestyles to accommodate the cost of buying a home.
4. Buyers don’t purchase at all

So what are these new mortgage rules and what effect will they have:

1) THE STRESS TEST

Anyone planning to purchase a home, not just those putting less than 20% down,  must qualify for a 5 year fixed mortgage using The Bank of Canada’s posted interest rate.  Most recently this rate is 4.64%  -  2 percentage points or more higher than many discounted rates being offered. Purchasers can negotiate a lesser interest rate afterwards but they have to qualify at 4.64%. Previously, this only applied to Buyers who made less than a 20% down payment and required a high ratio mortgage of more than 80%. But now it applies to absolutely everyone. Plus, the Stress Test requires that the home Buyer spends no more than an increase to 39% of their income on home carrying costs like mortgage payments, heat, hydro & taxes.  Another measure called Total Debt Service (TDS), which includes all other debt payments, now can’t be more than 44%.   

This ‘Stress Test’ will limit the size of the mortgages some borrowers can take out. And it aims to make sure that home Buyers could still afford their mortgage payments if interest rates increase.   

Non-bank lenders, like First National (Canada’s largest non-bank mortgage lender) is already feeling the pinch.  They lend mortgages of about $22 million a year – and they’ve already said that this will impact about 41% of its insured residential mortgages.  And there’s likely to be a 10% drop in lending because its loans won’t qualify for insurance.  Even their stock has dropped and it’s temporarily halted loans for rental properties and to self employed people who can’t verify income.

There are also lenders known as ‘shadow lenders’. Instead of using cash deposits like the banks do, they use money from groups of investors and they aren’t subject to the same scrutiny as major financial firms. Private lenders are neither regulated nor required to carry mortgage insurance. And they’re more likely to hand out bad loans.

Why did the Government do this? They’re responding to the sharp rises in house prices in Toronto and Vancouver, which could increase the risk of future defaults if the mortgage rates rise. With these new measures Buyers can only borrow what they can afford, but it means they will not have as much purchasing power in a hot market like we have today.

Other considerations:

1. If a Buyer was pre-approved prior to this rule change it does NOT mean they will still be approved for the same amount/and or rate especially if the lender based the pre-approval on a fixed rate, as it won’t be available anymore.
2. If someone was approved for a new construction home and the transaction doesn’t close until 2017, they’ll need to be pre-approved again using these new rules.
3. And remember that in Feb this year, the down payment on a home more than $500,000 became a minimum of 10%
4. Refinancing a mortgage with a Lender other than an Owner’s current one will require a full reapplication subject to these new mortgage rules
5. The amount of a Home Equity Loan, which adds to a current mortgage, may also be subject to an application to meet the requirements of these new mortgage rules
6. First time Buyers applying for a CMHC insured mortgage (ie: less than 20% down payment) must have a beacon credit score of 600 or more.

Some questions:

1. Will these measures force more volume out of the traditional banks and into unregulated lenders?
2. Will Buyers still run to these private and/or shadow lenders so they can qualify for short-term mortgages with lower requirements?  And will they even think about the future when they’ll they have to refinance and the rates have increased? We’re likely to see evidence of default for those who’ve taken these short-term mortgages when the interest rates start to rise.
3. Will this really affect homes above $1,000,000?
4. Will home prices fall in the next year as these rules come into effect?
5. Will it have any impact on the red-hot condo market? “Getting into the market” by purchasing a condo is an affordable route for many first time purchasers and can easily be much less than $1million.  However, the newly built and pre-construction condos can easily cost, in the city’s core, between $800 and $900 per square foot. Add in the condo fees and the cost increases even more.  
6. Will potential Buyers not buy at all? There are 60 new apartment buildings being built in Toronto with condo-style amenities. The rents start at $2500 - $3000/month.

Wise Buyers won’t go to these ‘Shadow Lenders’: they’ll just cut back on their spending and not succumb to being over-leveraged. Which is what the Government wants: less personal debt so it can keep the interest rates low for business debt.

The Government is now also considering imposing new regulations for non-bank, Private and Shadow Lenders to free up the Banks to be more competitive.

2) NEW RESTRICTIONS ON INSURANCE FOR LOW RATIO MORTGAGES

Low ratio mortgages are those for borrowers who have 20% or more as a down payment.  As of November 30, 2016,  new rules restrict insurance for low ratio mortgages based on the following criteria:

1. The amortization must be 25 years or less
2. The purchase price must be less than $1million
3. The property must be owner occupied – not a rental property

WHY? This hopefullly will reduce the Government’s exposure to residential mortgages for properties over $1million, sales of which have increased so much in Toronto & Vancouver in the last couple of years.

3) NEW REPORTING INCOME TAX REPORTING RULES

Currently any financial gain from selling an Owner’s primary residence is tax-free and doesn’t have to be reported as income. As of the 2016 tax year, it’s still tax-free (ie: no capital gains tax) but the sale of the primary residence has to be reported at tax time to the CRA.

WHY?  The Federal Government has unsupportable evidence, as well as reports from the media showing that foreign investors are flipping homes in Canada falsely claiming the primary residence exemption.

4) FOREIGN INVESTOR RESIDENCY – CLOSING A TAX LOOPHOLE

In order to claim the primary residence tax benefit, someone purchasing a property in Canada must be a resident of Canada and show evidence of this at the time of the purchase. 

WHY?  Many foreign investors are buying properties and selling them without ever having lived in Canada, or in these homes, and are avoiding the required Capital Gains Tax payment.

5) LOAN RISK SHARING    

The Government wants to limit its financial obligations in the event of any general mortgage default and to promote prudent lending practices.  So it’s reviewing Canada's “Lender Risk Sharing.” policies.

Currently, if there's a default, the Federal Government is responsible for 100% of an insured mortgage. We're one of the only countries in the world to have this policy. So the proposal is to have lenders, such as the banks, absorb part of that risk.  This would critically change the way Canada's finance system would work. And it could potentially lead to higher mortgage rates for home Buyers to offset the increased risk the lenders will have to take on.

So…will the Government’s new rules succeed? Will they solve the issue of housing affordability in Canada? When will we see any effect?  Will there be a slowdown/ reduction in personal debt and a moderate cooling of the overheated Real Estate market? Will our interest rates stay low so this all might work?  What happens should the U.S. raise their rates and it forces the Loonie down even further?

This Seller’s market could slowly become a Buyer’s market & decrease prices because people won’t be able to afford homes in what is now a ‘very hot’ market.   Over time it could balance supply and demand and make the housing market much more affordable.

We need to make these adjustments and watch what happens.