Starting June 1, Canadian homebuyers will face tougher mortgage stress test rules that will decrease the buying power of most borrowers.
The move, announced by the country’s banking regulator in May, was in response to an overheated market that has already started to see signs of cooling.
The pace of home sales seen at the start of the year started to slow in April as the number of homes sold fell by 12.5 per cent compared with the record high set in March, according to the Canadian Real Estate Association (CREA).
Even prices in the country’s largest market have started to stall. The average selling price for the Greater Toronto Area was $1,090,992 in April, down slightly from $1,097,655 the previous month, according to the Toronto Regional Real Estate Board.
Who do the new rules impact?
The new mortgage stress tests will affect Canadian homebuyers applying for or renewing a mortgage.
The new qualifying rate on uninsured mortgages – where the down payment is 20 per cent or more – is now either two percentage points above the contract rate, or 5.25 per cent, whichever is higher.
Before June 1, any buyer whose down payment was 20 per cent of the purchase price or more had to show they could afford mortgage payments if the interest rate was two percentage points higher than what the bank is offering them or 4.79 per cent, whichever was higher.
After the Office of the Superintendent of Financial Institutions (OSFI) announced the changes earlier this month, Finance Minister Chrystia Freeland said the federal government would align with the regulator by establishing the same qualifying rate for insured mortgages – where there’s a down payment of 20 per cent or less – for mortgages approved on June 1 or later.
“Insured borrowers are about a quarter of the market,” Rob McLister, mortgage editor of rate comparison website RATESDOTCA told Global News. “And so these folks are generally earlier in their careers. They have less financial resources … so when you reduce their buying power, it has a disproportionate impact.”
James Laird, co-founder of ratehub.ca and president of CanWise Financial, echoed that sentiment, noting this policy will hit first-time homebuyers particularly hard.
“It does impact everyone. It doesn’t matter what your income is, whether you make $50,000, $100,000 — your affordability is reduced,” he said.
“However, it’s first-time homebuyers who are the ones who are struggling to get into the market. They’re usually the ones purchasing at the maximum possible affordability. So it’s first-time homebuyers who are going to feel the impact of this change, even though it does affect everybody.”
How much will they affect my buying power?
The move to implement tougher stress tests will reduce borrowers’ theoretical buying power by a little over four per cent, according to McLister.
“In practice, it’s generally only the people that have high debt-to-income ratios to begin with that are going to be impacted by this,” he said. “And that could be roughly one out of 10 uninsured borrowers, if you use OSFI’s data, and roughly one out of five insured borrowers.”
Laird sees a similar impact arising from the new rules, saying buyers will see their borrowing power reduced by about five per cent.
As an example, a family with an annual income of $100,000 with a 20 per cent down payment and five-year fixed mortgage rate of 1.78 per cent amortized over 30 years would qualify for a home valued at $651,000 under the previous 4.79 per cent qualifying rate, according to ratehub.ca.
Under the new stress test rate of 5.25 per cent, that family’s maximum affordability would decrease to $618,000.
Doug Porter, BMO’s chief economist, agrees the new rules could reduce the buying power of someone who borrows close to the limit by about four to five per cent.
“So, not trivial, but probably not a game-changer,” Porter told Global News.
Still, Porter says the move is a “very reasonable step, given how hot the market has been.”
Will the new rules help lower home prices?
The new mortgage stress tests alone likely won’t put a huge dent in home prices, experts say.
“This enhanced stress test certainly puts some downward pressure, but it’s by no means the only factor that’s going to determine the strength of the housing market,” Laird said.
“There’s still lots of demand. Rates are still low.”
He added that once the pandemic eases, an increase in immigration will likely further fuel demand, putting added pressure on the market.
Porter said the new mortgage rules could slightly dull the market, but agreed it likely won’t significantly cool conditions.
“It’s a small step, and is unlikely to slow the market in isolation,” Porter said. “Having said that, there are some signs that things are calming a bit … and the mildly tougher stress test could add to that cooling.”
McLister said the shorter-term impacts of the new mortgage rules will likely be a bit more subdued than what we might see when interest rates eventually go higher.
“This is alone wouldn’t knock home values off their perch,” McLister said. “What is more interesting is if you ask yourself what happens when rates start going up. So, if you look back in time over the last four or five rate-hike cycles, the Bank of Canada has raised rates roughly six or seven times, on average. The bond market is projecting about eight rate hikes until we get to until we start levelling off.
“So if regulators baked even half of that rate increase, one percentage point, into the minimum stress test rate, buying power would plunge. We’d go from 5.25 per cent as your minimum rate that you must prove that you can afford, to 6.25 per cent. And that would reduce buying power between 12 and 13 per cent.”
What happened the last time mortgage rules were tightened?
When OSFI first implemented the mortgage stress test for uninsured mortgages in 2018, homebuyers saw their purchasing power reduced by about 20 per cent.
“This a little over four per cent is much less impactful,” McLister said. “But we also had home prices that weren’t as extreme as in the previous 12 months.”
The move in 2018 spurred a rush of buyers before the rules took effect. This time around, there haven’t been the same reports of frenzied buying activity with the change being less dramatic.
As for the buyers who will feel the impacts of this, McLister points out Canadians have proven to be resilient.
“As you saw, after 2018, Canadians are unbelievable at adapting,” McLister said. “They find co-borrowers. They get more help from mom and dad. They buy further out from the city where prices are a little less. They settle for a smaller home…. There’s all kinds of ways people adapt.”
“And, you know, we’re going to see that this time around, too.”