In January 2018, the Federal government rolled out a new stress test mortgage qualifying rule which has been a hot topic among industry professionals and politicians for the past year. To the average Canadian though, it has been difficult to determine how it actually affects them and what it really means.
To better understand the new stress test, let's first take a stroll down memory lane and see how we got to where we are.
2008 - Global Financial Crisis
Mortgage rules which led to the housing crash in 2008 were wild. Looking back, it is hard to imagine a scenario where there would NOT have been a financial crash.
- 100% financing ($0 down payment required)
- 40 year amortization
- 5% down payment for rental properties
- No limit on your maximum Gross Debt Service ratios (cost of housing vs your income) with good credit
- You could even refinance to pull out up to 95% of your equity
Imagine you spent over half of your income just to service your mortgage on a 40 year amortization with zero equity in your home? This was in addition to the plethora of other consumer debts which you might have had including a car loan, credit card debt, RV loan etc. A job loss, or interest rate increase would have devastating consequences - and it did.
An immediate response in July 2008 to the scene unfolding south of the border was to eliminate 100% financing, reduce the maximum amortization to 35 years and introduce minimum credit scores and debt service ratios.
2010 - 2016 Changes, changes and more changes...
During the rebuilding period after the crash, a number of changes were implemented in order to strengthen the security of the housing lending market. These changes were done sporadically and sometimes in stages over a 6 year period and included:
- Decreasing the maximum amortization period from 35 years to 30 years for buyers with over 20% down payment
- Decreasing the maximum amortization period from 35 years to 25 years for buyers with less than 20% down payment (known as high ratio mortgages)
- Minimum down payment for rental properties increased to 20%
- Maximum equity take out on refinancing dropped from 95% to 80%
- The removal of default insurance possibilities on properties over $1 million
- Increased down payment requirements for properties over $500,000
- Tougher qualifying guidelines on self employed individuals
- An increase in default mortgage insurance premiums
- Introduction of a foreign buyers tax of 15% for all non-residents and corporations outside of Canada
And in October of 2016 we saw our first taste of the stress-test which was rolled out for all mortgages with less than 20% down payment to ensure that buyers were able to qualify at the Bank of Canada 5 year posted rate which, at the time, was sitting around 4.64%.
2018 January - Implementation of the current stress test
The changes in January last year were actually relatively minor compared to the previous 10 years worth of policy changes but seemed to be the straw that broke the camel's back so to speak.
The implementation of the new mortgage stress-test meant that anyone purchasing a home, with any amount of down payment, now needed to qualify at either the Bank of Canada benchmark rate OR 2% higher than the rate being offered to them - whichever was higher. The Benchmark rate also increased to 5.14% at that time, and then increased again in May 2018 to the current rate of 5.34%.
In short, this means that if you are being offered an interest rate of 3.00% you must be able to qualify for that mortgage as if your rate was 5.34%. Or if you were being offered a higher rate like 4.00% you would need to qualify for your mortgage as if the rate was 6.00%. This is also regardless of how much equity stake you have in the property.
How does this affect YOU?
This new criteria on it's own would not have been so hard to swallow, but combined with a shorter maximum amortization period of 25 years for high ratio mortgages, slowly rising interest rates and higher down payment requirements it is remarkably more difficult to buy a new home today than at any point up until now. In short, you have much less purchasing power than you would have had just over a year ago.
This can be a hard pill to swallow for buyers who may have witnessed friends and family purchasing a year or 2 ago and being approved for substantially more house than what they can now shop for. This has also presented itself as a major crutch for those wanting to refinance or transfer their mortgages that suddenly do not qualify for their own home. Even in some scenarios, those who were hoping to upgrade homes are finding themselves only able to qualify for roughly the same amount they did before despite income increases.
On the positive side of the coin, the stress test means that buyers have extra assurance that they can comfortably continue to pay their mortgage if the interest rates increase by 2%. This does have benefit to buyers who otherwise may have spent more than they probably should.
And, as we may all be too aware, self-regulation in the spending department is not a common trait. Particularly among Albertan's who carry the highest consumer debt in Canada at an average of $28,155 per household (NOT including mortgage debt). A survey by CMHC (Canadian Mortgage and Housing Corporation) that came out in late 2018 found that 98% of first time home buyers who purchased with less than 20% down payment spent the maximum end of their budget when purchasing a home.
A second (yet, not so positive) effect has been a dramatic drop in housing prices as a result of both the mortgage rules and the fragile employment of the oilfield sector which means that those who can afford to purchase right now are benefiting from a buyers market with many homes going for tens of thousands below what their market value was only a couple of years ago.
The future of mortgage rules
The effects of the stress test and mortgage rules over the last 10 years have a much further reaching consequence, which is why politicians are beginning to weigh in on the matter.
In 2017, the construction industry made up 10.5% of Alberta's workforce through new developments, new builds, commercial buildings and infrastructure to service new homes.
Indirectly - retail professions like granite/flooring/blinds/cabinet makers, trades like Plumbers and Electricians, furniture sales, home decor, home security, landscaping businesses, Real Estate agents, home appraisers, inspectors, lawyers, mortgage brokers and the financial sector - the list goes on.
The reality of massive job losses in one of Alberta's most important economic sectors is becoming a looming threat. Something which was highlighted by the bankruptcy and collapse of one of Alberta's most prominent builders ReidBuilt Homes in late 2017.
Therefore, there is no surprise that the stress test has popped up in recent weeks as a campaign item for the Provincial election this spring as well as on the Federal level since the construction industry along with the Real Estate and Mortgage industries has begun lobbying the government to relax some of their rules.
While a return to the wild west mortgage rules pre-2008 is not in the cards, nor would we want it to be, some changes will need to be made to reflect a normal housing market. Therefore, you can expect, as campaigns for elections both Provincially and Federally begin to kick off in the coming months to hear about mortgage rules and the stress test a lot more often.
Questions about this topic? Drop me a line, I would love to chat!