Starting January 1, 2018, the Bank of Canada is making some changes to the mortgage rules for uninsured borrowers that can affect your ability to purchase a home. In short, anyone with a 20 percent or greater down payment will now have to pass a “stress test” to ensure they can handle potential increases in mortgage rates.
This move is designed to decrease the risks for households with high levels of indebtedness as interest rates rise. In fact, anyone with less than 20% down payment will be unaffected by the new rules.
Learn more about the requirements to see if you need to make a change in your plan to buy a home.
Stress Test For Insured Mortgages
Back in October 2016, a new stress test was introduced for those purchasing homes with a down payment of less than 20 percent (a high ratio mortgage). It stated these borrowers had to qualify for a loan based on the Bank of Canada posted 5 year conventional fixed mortgage rate. The posted rate is the mode of the 5 year conventional fixed mortgages advertised by Canada's top 6 banks.
To counter this, those who were close to having a 20 percent down payment usually waited a bit longer to purchase their homes so they could avoid the stress test.
The New Stress Test For Uninsured Mortgages
The new version of the stress test applies to those with a 20% down payment or more (a non-insured or conventional mortgage). Homebuyers must now qualify for the higher of either the Bank of Canada benchmark rate (currently 4.89%) OR the rate from the lender plus 2%.
Decreasing Maximum Loan Amounts
Essentially, when you’re qualifying for a mortgage based on a higher interest rate, it decreases the maximum amount you can borrow. MortgageJake at Urbaneer.com suggests a quick rule of thumb is you should be able to qualify for a home around five times the amount of your annual income. In the past, you would have qualified for a loan around seven times the amount of your annual income.
That sounds like a big difference, but the truth is few Canadians are actually purchasing homes at that upper limit of the loan amount. The bank’s maximum loan amount is based only on your monthly income and the amount of debt you owe. It doesn’t factor in things like private school tuition, kids’ after-school activities, or expensive vacations, so most Canadians set a lower limit for themselves. No one really wants to spend a large percentage of their income on their mortgage.
Differences in Refinanced Loans
It’s important to note these new rules also apply for some refinanced mortgages. However, if you’re planning to refinance with your current mortgage lender, you will not have to pass the new stress test. This might be a big reason to stick with your current lender, but if you have no worries about passing the stress test, you should shop around to get the best rates.
Countering the Effects
If the new stress test does prevent you from purchasing the home you’ve had your eye on, you do have a few options. First, you can save a bit more money for a higher down payment. If you’d need a $400,000 mortgage for the house of your dreams, but you’ll only qualify for $380,000, you could wait until you have that extra $20,000 before purchasing. You may even be able to borrow money from your RRSP.
You can also take a second look at more affordable homes. For instance, if a 2,000 square foot home with many upgrades is now nearly out of reach, a 1,600 square foot home with just the necessary upgrades might look just as nice. Of course, you have certain wants or needs you don’t want to compromise on, but making other choices could get you into a home quickly. Be upfront with your builder or condo developer about what you want and your budget so he or she will be able to help you craft a home that meets all your needs.
Avoiding the Stress Test
The new mortgage rules officially go into place on January 1, 2018. You may be able to avoid the stress test by purchasing your home before the end of the year. Shop around for a lender and mortgage that has the right combination of rates and rate holds for your needs and potential move-in date. Once you have a pre-approval, get out there and buy smart.
The goal of these changes is to ensure Canadians are purchasing affordable homes - protecting them and the economy. If you’ve already been planning to purchase a home within your budget, you have nothing to worry about.