A lot has happened since Ottawa rolled out the mortgage stress test.
The idea was to help ensure that Canadians could keep up with their mortgage payments even with rising interest rates. And those borrowing costs are now quite a bit higher than when the rules came into effect.
In October 2016, when the government introduced the stress test for insured mortgages, those with a down payment of less than 20 per cent of home value, were being tested against a benchmark interest rate of 4.64 per cent. Today, that rate stands at 5.34 per cent.
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That has the real-estate industry reportedly pressing the government to take steps to loosen up requirements for first-time homebuyers, for example, by stretching out the maximum amortization period for insured mortgages from 25 to 30 years.
At the same time, though, those very rules have helped take the sizzle out of most real-estate markets in Canada. Home prices in most major cities are lower today than they were early last year, when Ottawa cast a wider net with a stress test for mortgage applicants putting down 20 per cent or more of the home value up front.
The benchmark prices of a home in Metro Vancouver, for example, is 4.5 per cent lower than it was in January 2018. In Toronto, average prices eked out a gain of a mere 1.3 per cent. Nationally, the average price of a home at the start of this year was 5.5 per cent below what it was at the beginning of 2018.
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While lower price tags are bad news for sellers, they lower the stress-test bar for buyers, tempering or offsetting the impact of higher interest rates.
So what does it take to get your mortgage application approved in Canada’s major cities?
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The mortgage stress test: then and now
We first raised that question nearly a year ago, when we asked financial products comparisons site Ratehub.ca to calculate the minimum income necessary to pass the stress test for homebuyers looking to purchase an average-priced home with a 20 per cent down payment, a 2.99 per cent five-year fixed rate mortgage and a 25-year amortization. We used March 2018 home prices.
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This time, we repeated that exercise using January 2019 home prices and a 3.29 per cent interest rate, one of the lowest available on Ratehub.
Here’s how January 2019 compared to March 2018:
In most cities, mortgage applicants would have a better shot today than 10 months ago. In Vancouver, for example, the average home price in January was nearly $65,000 lower than it was in March of last year. That translates to almost $13,000 less to put down a 20 per cent down payment and around $10,000 less in minimum income necessary to pass the stress test. Buyers in Toronto, Calgary and Edmonton would enjoy similar gains.
Of course, the comparison isn’t perfect. In much of Canada, January is one of the most frigid months in terms of both temperatures and real-estate activity. Things, on the other hand, tend to thaw out in March, when prices bounce back as the spring real-estate markets begin.
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Still, comparing the national average home price between January 2019 and January 2018 yields a similar result. Thanks to lower home prices, the minimum household income required to qualify for the average Canadian home for a buyer with no other debt, a 25-year amortization and 20 per cent down is $83,639 today, compared to $86,880, according to numbers provided by Toronto mortgage broker Robert McLister.
Overall, “the stress test has been an unequivocal success in stabilizing home prices,” said McLister, founder of rate-comparisons site RateSpy.com and mortgage planner at intelliMortgage.com.
But tougher mortgage rules have also steered more buyers toward cheaper homes, pushing up the prices of lower-end properties, as well as rent, he added.
“People trying to get into the market are really struggling,” said James Laird, co-founder of Ratehub Inc. and president of CanWise Financial mortgage brokerage.
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So what about a 30-year mortgage?
The plight of first-time homebuyers is fuelling a revival of the 30-year mortgage. The option is already popular among buyers who can afford a down payment of 20 per cent or more. And politicians are reportedly thinking about re-introducing the longer amortization for insured mortgages as well.
Finance Minister Bill Morneau is said to be mulling the option — something that could be addressed in its pre-election budget, set to be tabled on March 19.
NDP Leader Jagmeet Singh has also recently adopted the idea, part a broader suite of home-affordability measures he supports.
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The basic idea is simple: Spreading out a mortgage over a longer period of time lowers monthly mortgage payments, all else equal. This can not only free up some much-needed cash for households on a tight budget but can also push some prospective buyers just over the stress-test bar.
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In our example, a $410,000 home in Calgary would come with monthly mortgage payments of around $1,600 with a 25-year mortgage. But that goes down to about $1,430 a month with a 30-year amortization. Those lower mortgage installments mean a homebuyer with no other debt would need to be making around $65,000 a year to qualify for the loan instead of $72,000.
In general, a 30-year mortgage allows buyers to get 10 per cent more mortgage for the same monthly payment, Laird told Global News.
But longer mortgages come with two notorious downsides. One is that homeowners who stick to the regular payment schedule will end up forking out considerably more in interest over the life of the loan.
To use numbers from our data set, buyers with 20 per cent down on a $777,000 Toronto home would pay around $316,000 in interest with a 25-year amortization, but $387,000 with a 30-year mortgage — a difference of almost $70,000.
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The other catch is the risk that an extra-long mortgage will interfere with homeowners’ ability to save for retirement.
Experts are divided on the merits of the 30-year mortgage.
Laird said that buyers can and tend to accelerate their mortgage payments as they get older. In general, people earn more as they advance in their careers and many will use the extra cash to hack away at their mortgage debt.
“Just because you start with a 30-year mortgage, doesn’t mean you end with a 30-year mortgage,” he said.
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Others, however, take a dimmer view.
A 30-year mortgage is “a Band-Aid on expensive home prices, but that doesn’t mean it’s a good option financially in the long run,” said Jason Heath, a fee-for-service financial planner and managing director at Objective Financial Planners.
“It’s not uncommon for someone to take out a mortgage and add to it or extend the amortization over their lifetime. So, a 30-year mortgage can easily become longer just on that basis,” Heath said.
Rising interest rates could also force homeowners to further stretch out their amortization at renewal if they can’t afford higher monthly payments, Heath noted.
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For homebuyers with small down payments, though, there would be less of a temptation to add to the mortgage through refinancing, said Arpad Komjathy, a certified financial planner and mortgage broker.
Refinancing without having at least 20 per cent equity in the home is “very difficult,” Komjathy said.
So a couple with 5 per cent down payment of $25,000 on a $500,000 condo would have to wait until they’ve built up at least $100,000 of equity before refinancing, he added.
“That doesn’t allow them to take on more debt for a long time,” he added.
Overall, he said, especially those living in expensive cities like Toronto, where “downtown rent is crazy expensive,” a 30-year mortgage makes sense for millennial buyers.
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Canada has seen longer mortgages than that. The maximum amortization for an insured mortgage was 40 years in 2008, but Ottawa had gradually reduced it to 25 years by 2012.
A return of the 30-year amortization even for buyers with smaller down payments would be a return to the past.
One question about the future, though, is whether the extra demand for housing generated by newly qualified buyers will push home prices and by how much.
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