A new year usually means bringing out the bubbly – but homebuyers are less inclined to cheers the beginning of 2018, as January 1st ushered in regulations that make it tougher to get a mortgage.
Guideline B-20 is the latest crop of mortgage rules introduced by Canada’s federal banking regulator, the Office of the Superintendent of Financial Institutions (OSFI). It requires all low-ratio mortgage applicants (those paying more than 20% down) and refinancers undergo a stress test to ensure they can still afford their monthly mortgage payments should rates rise.
Under the new criteria, borrowers must qualify at either the Bank of Canada benchmark rate (currently 4.99%), or their contract rate plus 2% – whichever is higher.
The stress tests will reduce homebuying budgets by 20%, and experts think they could remove as many as 10% of prospective buyers from the market.
As these significant changes are absorbed, it will have implications for the market as a whole – here are three trends real estate watchers should keep an eye out for in the wake of B-20.
Detached home demand will fall
With such a sizeable bite out of homebuying budgets, those in the market will seek more affordable options – and that will further squeeze demand and prices for the expensive detached home segment, which has softened steadily since the Fair Housing Plan was introduced in April.
Between March and December, house prices fell $224,552 – down 18.4% – in the Greater Toronto Area (GTA). Keeping in mind seasonal factors – early spring is traditionally a busy month for real estate activity while the holidays are a “dead zone” – it has been a steady, and apparent decline in the months following the Plan.
However, despite double digit depreciation, houses haven’t become significantly more affordable for most buyers in the GTA, with an average price of $989,870 in December.
That’s still considerably out of reach for those earning the median Toronto household income of $78,280. Assuming great credit, a 20% down payment, and a 30-year amortization, a median-earning household would qualify for a mortgage amount of only $602,008, at a rate of 2.79%. That’s further whittled to $481,926 when stress tested at the Bank of Canada’s qualification rate of 4.99%.
As well, with many detached homes in the GTA priced above $1 million – which requires a minimum 20% down payment – B-20 directly targets the buyer pool for much of today’s available detached inventory.
Condos, on the other hand, will continue to lead the housing market in terms of price growth and sales, as buyers flock to their most affordable options. Multi-family housing surged in value over the course of 2017, the Toronto Real Estate Board (TREB) reports, with condo prices rising 23.1% to $512, 478, compared to 12.8% in the detached sector, 16.3% for semi-detached homes, and 16.5% for townhomes for sale in Toronto.
Borrowers will mix up their mortgage options
Guideline B-20 is expected to remove some buyers from the market, but that doesn’t mean they’ll be entirely without options. OSFI’s new rules are for federally-regulated lenders, which means credit unions (which are provincially regulated) can be a refuge for those who fail their stress tests.
It’s anticipated that these lenders will see a considerable boost in business, though their offered interest rates may not be as competitive as their federally-regulated counterparts.
Stress testing isn’t the only change ushered in by B-20; the new rules also ban the use of “co-lending” or “bundled” mortgages, which combine up to three mortgages to help credit- or cash-strapped borrowers exceed their required loan to value ratios.
The new rules, some experts worry, could instead push these borrowers to the unregulated private lending market, which can be rife with risks and a very high cost of borrowing.
“For those who don’t fit within the ‘Big Bank’ criteria, it can be very difficult to obtain this kind of financing, and so bundled loans have been a great asset,” says Mike Bricknell, a mortgage broker at CanWise Financial. “Restricting this type of loan will reduce these borrowers’ options, sending them instead to the dark ‘private’ loan market, where super-high rates and fees are the norm. In these situations, repayments tend to be interest-only, and can make it even more difficult for those in challenging financial situations to dig themselves back out.”
Buyers may go the high-ratio route rather than low
This isn’t the first time OSFI has tightened requirements for mortgage hopefuls. In October 2016, a similar stress test was rolled out for high-ratio mortgage borrowers (those who pay less than 20% down), requiring them to qualify at the benchmark rate.
Because high-ratio borrowers carry greater amounts of debt and have less equity in their homes, they must also pay for mortgage default insurance, the cost of which is rolled into their regular mortgage payments.
However, despite the higher risk posed by these borrowers, the fact that their mortgages are insured gives lenders greater peace of mind. As a result, they’ll often offer this group cheaper mortgage rates – sometimes by as much as 0.40 – 0.50%.
Previously, when only high-ratio borrowers were stress tested, it made sense to boost down payments by any means possible to avoid stress testing altogether. In many cases, this meant help from the “Bank of Mom and Dad,” who stepped in with financial gifts large enough to boost a borrower from the high to low-ratio threshold.
Now, however, as all new borrowers are stress tested, it can make more sense to purposely go high-ratio for the lower interest rate and potentially easier stress test criteria. These can equal to less paid on a mortgage over time, despite also footing the bill for mortgage default insurance. As a result, we may see more borrowers strategically make a 19% down payment, rather than the full 20.
Penelope Graham is the Managing Editor of Zoocasa.com, a leading real estate resource that combines online search tools and a full-service brokerage to empower Canadians to buy or sell their homes faster, easier and more successfully. Home buyers can browse Toronto real estate listings, as well as the Hamilton real estate market, including detached homes, townhomes, and condos in Hamilton.