November 30, 2016

New Rules Now in Place for Bank Bulk Mortgages

In October, new rules affecting mortgage qualification were put in place for homebuyers. Those paying less than 20% down on their home purchase must now undergo a mortgage “stress test”, qualifying at the Bank of Canada’s benchmark rate of 4.64% rather than the lower rates currently on the market.

That change was part one of two efforts to reduce risky borrowing practices in Canada and today, the second phase takes effect – and while this one targets the banks, it will directly impact how much home you’ll be able to afford.

What are the New Lender Mortgage Rules?

These latest rules will require mortgage providers– from Canada’s big banks to small, mortgage-only lenders – to adhere to high-ratio mortgage rules when insuring their bulk mortgage portfolios. But what does this mean?

Here’s a quick recap on how banks use bulk mortgages:

When a homebuyer purchases a home with less than 20% up front (called a high-ratio mortgage), they must by law also pay for mortgage default insurance as their debt is considered to be riskier due to its lack of equity.

Mortgages where more than a 20% down payment has been made do not require this insurance – but many of the banks choose to insure them regardless. The extra insurance isn’t just for peace of mind – it now means the bank can bundle up the mortgages it holds into investments (referred to as mortgage-backed securities or MBS), and sell them off. This is an important part of banks’ funding, especially for smaller lenders, who rely heavily on MBS sales to fund their mortgages. Large banks use this method too, though they have additional funding options due to their more diversified lines of business.

There are some types of mortgages that cannot be insured at all by consumers, as they always require at least 20% to be paid up front. They are:

• Mortgage refinances
• Mortgages on rental properties
• Mortgages with an amortization longer than 25 years
• Mortgages on homes priced over $1 million

Under the old rules, banks could still opt to insure these types of mortgages, and include them in their investment sales. As of November 30, 2016, they no longer have that option.

What Does This Mean for Mortgage Shoppers?

Having fewer mortgages available to sell as MBS will impact the banks’ bottom lines – and that means prices will rise for consumers.

While some of the smallest lenders will opt to no longer offer these uninsurable products altogether, the majority of banks will keep them on the roster, but at a premium between 10 – 25 basis points. That’s not a huge hit for borrowers – on a classic $400,000 mortgage, it’ll translate to an extra $30 paid per month – but it will limit their options in other ways.

Fewer Refinancing Options Available

Mortgage refinances – which account for 25 – 30% of transactions, will be most impacted by the changes and could restrict Canadians’ debt options. One of the most common reasons to refinance is to move high-interest debt to a lower interest rate – for example, rolling credit card debt at 18% per month into a 2.7% mortgage makes a lot of financial sense. Making this option more expensive or unavailable for Canadians could mean more borrowers will carry high-interest, unsecured debt.

Many homeowners may also choose to refinance in order to renovate and update their homes – a popular tactic in markets with “buyer gridlock”, where it has become too expensive to buy an upgraded property. Having decreased access to refinances could be a point of frustration for these homeowners.

Mortgage Rates May Keep Rising

While these changes are just taking effect now, their impact has already been felt in the market. In early November, TD hiked its Prime lending rate to 2.85% – a full 15 basis points higher than the rest of the Big Five Banks – despite no mandate to do so from the Bank of Canada. Mortgage payment timelines increased for their variable borrowing customers as a result, and is widely regarded to be a measure to offset these mortgage rule changes.

TD and RBC – in addition to a number of smaller lenders – have also hiked their fixed mortgage rates, with other banks expected to follow suit. While this is partly due to the “Trumpflation” effect of rapidly rising bond yields, it is also signals they’re tweaking what they can to compensate for less MBS issuance.

While it remains to be seen how lenders will continue to react, the new reality is it’s more expensive to be in the mortgage business, which will be reflected in rates. Other changes, such as proposed risk sharing, could increase the banks’ costs even higher in the months to come. It’s more important than ever for mortgage shoppers to know how the options offered by various lenders differ, and compare the market when searching for their home financing.