If you’re currently home shopping, make sure you’re able to qualify under the new rules. Let’s talk about the current mortgage rules and compare them to the new ones so you’re ready.
Current mortgage rules
Buyers who need a ‘high ratio’ mortgage are backed by mortgage insurance. These are buyers with down payments of 5% or greater but less than 20%. This is a mandatory program that insures mortgages under CMHC or Genworth to protect lenders in case the borrowers can’t pay their mortgage and subsequently default.
The four changes
1. The mortgage rate ‘stress test’
You’re going to need to pass a tougher stress test when qualifying for any insured mortgage. This applies even if your downpayment is more than 20% but your lender requires mortgage insurance. You can still avail of today’s low interest rates. The government is saying you should qualify based on a higher rate. That rate would be the Bank of Canada’s five-year fixed posted mortgage rate. As of September 28, that rate is 4.64%.
The GDS (Gross Debt Service) ratio and TDS (Total Debt Service) ratio are two other components of this stress test. In summary: you shouldn’t spend more than 39% of your income on home-carrying costs (mortgage payments, heating, taxes) and you shouldn’t spend more than 44% of your income on these costs plus your debt payments.
Why is the government doing this? Real estate prices, especially in heated markets such as Toronto and Vancouver, have risen sharply over the past few years. There is a higher risk of default if prices continue rising. This becomes more profound if interest rates rise and homeowners can no longer afford their mortgages. The government wants to prevent a fallout if homeowners bail on their mortgages due to higher interest rates.
2. New restrictions for low-ratio mortgages
Beginning November 30, there are specific criteria for any homebuyer applying for a low-ratio mortgage.
The amortization (period of the loan) must be 25 years or less
The purchase price is less than $1 million
Your credit score has to be 600 or greater
The property has to be owner-occupied
The government wants to protect its exposure on mortgages of homes that are $1 million or more. Considering the average detached home in Toronto is over $1 million, this drastically changes your options unless you have a greater downpayment and don’t require mortgage insurance.
3. Capital gains exemptions for primary residences
Selling your primary residence is tax-free. You don’t have to report it as income on your tax returns. When these changes come into affect, selling your primary residence remains tax free. But now it has to be reported to the Canada Revenue Agency.
This change is primary targeting foreign buyers who have been evading Canadian tax laws. They buy a home (as an investment), flip it, and sell it at profit without paying taxes. They do this by saying it’s their primary residence, even though they may not have lived there.
The government is making attempts to crack down on this practice. However, this response seems based more on the extensive media coverage and anecdotal (hearsay) evidence. More data is needed to actually see how many transactions involve a foreign buyer flipping property and evading taxes. Sure, I believe this is happening. Whenever there is an opportunity to benefit, anybody (not just foreign buyers) will take that opportunity. But it may not be as profound as we think. And it’s also unfair to think that EVERY foreign buyer is doing this — or that ONLY foreign buyers are doing it.
4. Lenders and the risks they take
Here’s something interesting for you to learn: according to current mortgage rules, who do you think is on the hook if homeowners default on a high ratio mortgage? The government. 100%. If homeowners default, the government has to cover 100% of the cost of an insured mortgage.
What are they going to do about it? They’re telling the banks and lenders to take some of the risk. This situation is unique in international real estate. Most other governments don’t take on the responsibility of home ownership defaults. If a massive default of mortgages were to happen, the government would be affected. Think about the finances and taxpayer money (i.e. bailouts) that this would entail.
This mortgage rule change could lead to higher mortgage rates. Lenders can no longer rely on the government to cover mortgage defaults. They would take on some of the responsibility. This would encourage more prudent and careful mortgage practices. Ultimately it could lead to higher mortgage rates so that lenders can afford to cover themselves for defaults.
What will happen next
This may seem like shocking news — but not really. We knew it was coming. About a week ago, I wrote about possible mortgage rule changes that were already being talked about. Now it’s a realty.
What does this mean to you?
If you’re currently in the process of buying a home, hang on tight. You’ll have to qualify under the new, tighter mortgage rules.
As far as home prices go — the current supply and demand issue especially in heated markets have resulted in sharp price increases. Changes to mortgage rates would dramatically affect affordability. This means home buyers won’t be able to afford as much ‘home’ as they could under the current rules. What will happen to home prices? You may not see as much rapid price jumps. But a drastic decline in prices would only happen if mortgage rates were to skyrocket, everybody were to start listing their homes for sale, or something globally catastrophic were to happen