Thinking of applying for a mortgage? You now have until January 1st before new rules, designed to make it tougher for borrowers to qualify, take effect.
The final version of Guideline B-20 – a banking regulation that increases the qualification requirements for mortgage borrowers and restricts certain types of mortgage arrangements – was officially announced this morning by the Office of the Superintendent of Financial Institutions (OSFI). Specifically, the changes will entail:
- All uninsured mortgage borrowers (those who pay more than 20 per cent down on their home purchase), will need to prove they can handle a higher mortgage rate. They will need to qualify at either the five-year benchmark rate published by the Bank of Canada (BoC) (currently 4.89 per cent), or at an extra 2 per cent on top of their contract mortgage rate – whichever is higher. Prior to this rule change, only high-ratio (less than 20 per cent down) borrowers were stress tested at the BoC’s rate.
- Alternative lending arrangements such as co-lending (when multiple lenders provide a mortgage), and bundled mortgages (when home financing is combined with another financial product) have been banned. In the past, these practices could be used by lenders to help borrowers with less-than-A status get a mortgage.
- Lenders must now adhere to dynamic loan-to-value ratios when qualifying borrowers, based on specific housing market factors and risk. This means you may need to satisfy greater LTV requirements if buying a home in an ultra-hot neighbourhood where home prices may be inflated.
Why Has OSFI Introduced These Rules?
OSFI is Canada’s federal banking watchdog and is responsible for regulating banks’ lending practices and underwriting criteria. One of its main objectives is to reduce the amount of risk posed to banks via their mortgage business; given how high housing prices currently are and the amount of debt increasingly taken on by borrowers, Canada’s lenders could be in a precarious position should the economy shift and mortgage holders default on their home loans.
Stated Superintendent Jeremy Rudin, “These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada.”
OSFI made an earlier attempt to reign in mortgage risk last October, when it implemented the stress test for high-ratio borrowers. However, those changes didn’t seem to take much effect, as home sales and prices continued to skyrocket in Canada’s hottest markets.
OSFI has also made changes on the lenders’ side as part of their Guideline B-21. Those included tougher underwriting rules for the banks to follow, as well as limitations on insurance for their low-ratio mortgage portfolios. Unlike high-ratio mortgages, where insurance must be paid for by the borrower themselves, low ratio mortgages do not require insurance. However, many lenders would choose to insure them on their end (using a product called bulk insurance), so they could in turn bundle them up and sell them as low-risk, mortgage-backed securities (MBS). These MBS were an important funding method for lenders, especially smaller ones that don’t have the diversified product lines offered by the big banks. OSFI has cracked down on all of these processes in its efforts to reign in risky borrowing.
Too Much, Too Soon?
While previous efforts haven’t done much to cool the housing market, many real estate experts and analysts have expressed concern that the latest round of B-20 could be too aggressive of an approach, especially given today’s softer housing market. Sales conditions have slowed in both Vancouver and Toronto, following new taxes that target foreign buyers, speculative investors, and empty homes. The Bank of Canada has also recently hiked interest rates, making the cost of borrowing more expensive for variable mortgage holders.
Tim Hudak, CEO of the Ontario Real Estate Association, declared that the new measures would equate to a “war on home buyers”, while other industry experts have expressed concern it will have a depressing effect on the economy, and will wipe out hundreds of thousands of jobs in the real estate resale and new build industries. A recent report from the Fraser Institute also found the OSFI measures could cause “more harm than good”, stating the regulator has the tools it needs to control risk without going after borrowers.
Bad News for Vulnerable Borrowers
There are also concerns that these changes will put the most vulnerable borrowers in more precarious debt positions – as they will no longer have access to bundled and combined products from A-lenders, they’ll increasingly turn to alternative lenders, such as private financers, who typically offer some of the highest rates.
“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, mortgage broker with 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.”
How Will This Effect Mortgage Qualification?
Combined with OSFI’s new measures, the impact on home buyers could be punitive. James Laird, President of mortgage brokerage CanWise Financial, recently told Huffpo Canada that home buyers may see their affordability chopped by as much as 21 per cent.
Let’s assume a home buyer is purchasing a detached house in the City of Toronto, at the average price of $1,355,234 (according to September 2017 number from the Toronto Real Estate Board). They’ve made a 20 per cent down payment of $271,047, and are applying for today’s lowest five year fixed mortgage rate of 2.83, amortized over 25 years.
Under the new rules, they will need to either add 2 per cent to that contract rate, or qualify at the BoC’s rate of 4.89 per cent – whichever is higher. In this case, it’s the latter.
That means our purchaser will need to prove they can carry a monthly mortgage payment of $6,238, compared to their actual monthly payment of $5,037.