New Mortgage Rules (Q3 2017)
In early October 2016 the federal finance minister announced new mortgage rules. The intent of the rules were to slow down the housing market and protecting the Canadian Government from potential mortgage default risks.
Unlike before, the new rules were not rolled out effectively. As a result, many consumers are still confused about their mortgage options and which rules apply to them. The new rules are a major departure from previous rules. Consumers will need a lot of education to understand the impact on their finances.
One of the greatest consequences of the new mortgage rules is that there is no longer one interest rate for a specific term e.g. 5-years fixed. This makes mortgage interest rates on the internet a minefield. It’s impossible for lenders to post all the interest rates for all options on their websites. This also makes it impossible for the borrower to know which interest rate applies to them. Now, more than ever, it is important to get the best mortgage, not just the lowest interest rate, which will inevitably lead to a nasty, costly mortgage.
Before we start here are some important terms to understand:
- High-Ratio Mortgage: This is sometimes called an insured mortgage. It is a mortgage where the borrower has a down payment of less than 20%. High-ratio mortgages are always insured against default by lenders with one of Canada’s three mortgage default insurers. The borrower always pays the insurance premium and it is most often added to the mortgage.
- Conventional Mortgage: A mortgage where the borrower has a down payment of 20% or more. Conventional mortgages might still be insured by the lender, but the lender pays the premium on behalf of the borrower. This is to protect itself against default by the borrower. This type of insurance arrangement is called “back-insurance”. The vast majority of lenders do back-insure conventional mortgages.
- Mortgage Switch: When a mortgage is switched from one lender to another at the maturity date without making changes to the mortgage itself. In other words, the borrower continues with the same mortgage without taking out any money, changing title, or adding/removing a Home Equity Line of Credit (HELOC) etc. Collateral Mortgages, a mortgage with a HELOC, nor rental property mortgages qualify as switches. If a mortgage cannot be “switched”, it by default becomes a refinance.
- Refinance: An existing mortgage which is not a switch and/or the borrower breaks the mortgage, adds or removes a HELOC, remove or add someone to the mortgage, whether done mid-term or at the term maturity date.
Four rules were announced, with the last one not being a rule yet, but rather a notice of future action by the government.
1. Stress Test for All Insured Mortgages
All high-ratio mortgages have to qualify under the new “Stress Test”, which is at the higher Mortgage Qualification Rate (MQR). Since mortgage rates are currently very low, the purpose of the Stress Test is to ensure borrowers can still qualify for their mortgages, if mortgages rates increased. The MQR is the posted 5-year fixed rate, as published by the Bank of Canada every Thursday. The Bank of Canada surveys the 5-year fixed rates of the 6 major banks every Wednesday and uses the average of those rates to set the official benchmark rate. The MQR is currently 4.84%.
How it works: Once the borrower qualifies at the higher MQR rate, they get the actual, lower, contract rate.
Previously only variable rate mortgages and mortgages with fixed rate terms of less than 5 years qualified this way. Now all high-ratio mortgages, have to qualify this way.
- These mortgages will get the best interest rates since the lenders are protected by insurance against borrower default.
- This rule will reduce the maximum mortgage that someone can qualify for. E.g. Consider a borrower earning $75,000 with a 5% down payment:
Old Rules Max. Purchase Price: $465,000
New Rules Max. Purchase Price: $379,000
2. New Rules for Conventional Mortgages
These types of mortgages have a down payment or equity of more than 20% and they have now been divided into two groups:
1. Insurable Conventional Mortgages
Lenders are able to back-insure these mortgages and borrowers have to qualify in the same way as insured mortgages. This means that the Stress Test also applies to these mortgages. All mortgages are insurable except for the ones listed below.
2. Uninsurable Conventional Mortgages
These mortgages cannot be back-insured and thus the lender carries the entire lending risk itself. This risk is translated to the borrower in the form of an interest rate premium. The follow 4 mortgages are now uninsurable:
- Amortizations of more than 25 years
- Homes with purchase prices higher than $1M
- Single family rental properties (legally zoned 2 to 4 plexes are still insurable)
This rule is the largest deviation from previous mortgage rules and has the following effects:
1. Insurable Conventional Mortgages
- Interest rates are now tiered. There is no longer one interest rate for e.g. 5 years, fixed. Different interest rates, for the same term length now apply, depending on the borrower’s down payment amount. Insured mortgages get the best interest rates followed by borrowers who have a down payment of 35% or more. Although it varies between lenders, borrowers can expect to see the following rate sliding scale for insurable mortgages:
- 20% – 25% down payment – Worst of the insurable rates
- 25% – 30% down payment – Better than (1)
- 30% – 35% down payment – Better than (2)
- 35% or more down payment – Best of the insurable rates, but still not as good as insured rates.
- Borrowers will qualify for less mortgage since these mortgages are also qualified at the MQR.
- Purchases and Switches are deemed insurable if the mortgage does not fall into the uninsurable category.
2. Uninsurable Conventional Mortgages
- Rate premiums apply. Since lenders no longer have default insurance protection, they have to “self-insure” these mortgages and thus the borrower will pay a rate premium. Although modestly higher, these interest rates are the highest of all AAA interest rates.
- A 30-year amortization is still available.
- These mortgages can still be qualified using the old rules, which are as follows:
- Fixed rate mortgages with a term of 5-years or more: Qualified at the Contract rate (actual rate)
- Any variable rate loans (Mortgages & HELOCs) and fixed rate mortgages with respective terms of less than five years: Qualified at the MQR.
- Additional rate premiums will apply to single family rental properties.
- Total Debt Service (TDS) & Gross Debt Service (GDS) Ratios for lenders have changed since these mortgages are no longer insurable. Lenders can make rules that are more conservative than the government’s rules. Unlike with insurable mortgages, there is no longer a single way that lenders qualify borrowers for a mortgage.
3. New Reporting Rules for Primary Residence Capital Gains Exemption
The sale of a primary residence will need to be reported to CRA at tax time. The capital gains from the sale or a primary residence are still waived, but the sale needs to be reported.
Under current laws, Canadians don’t have to report the income from the sale of a primary residence. As a result, some foreign buyers have been buying and selling homes without reporting the income since they illegally classify the homes as their principal residences.
This will currently only affect foreign purchasers.
4. Government Risk Sharing
The government is looking to share some of the mortgage default risks to lenders. This is just a heads up since no new rules have been announced yet.
Currently, the federal government handles 100% of defaults of insured mortgages. This is unique in the world and the government is looking to move some of that risk to the lenders.
Mortgage lenders will have to take on added risk which could result in higher interest rates for home buyers.
These rules have and will continue to have a significant impact on Canadian borrowers. Unfortunately, it makes home ownership much harder for first time home owners. However, these rules are here to stay and Canadians will have to adjust their lives accordingly.
We can also expect to see many further rule changes such as “risk based pricing”. Lenders don’t currently discriminate against borrowers with lower credit scores, as long as they meet the minimum credit score requirements. In the future, this might change and lenders might give better interest rates to borrowers with better credit.
The good news about future changes is that although the mortgage industry will still be very regulated, having diminishing insured mortgage products will cause lenders to become much more competitive and efficient. Although mortgage insurance has protected our banks, it has also made the banks less competitive and has made mortgage products stale. It is important to note that while insured mortgages protect financial institutions because they are backed by the government, the government is essentially every tax paying Canadian. It does not seem fair, neither does it make sense that ordinary Canadians should guarantee extremely profitable financial institutions that make a profit off them. Which other business has the privilege of being guaranteed by the government?
Although these rules can be confusing, they are not as bad as they seem. The best thing you can do is to make sure that you are educated well. Make sure you have a conversation with a mortgage broker who will guide you and educate you to avoid pitfalls when you need a mortgage. The new mortgage rules have many nuances that cannot be explained in this article, so it is important that you have a conversation with your mortgage broker about them. We will guide you and explain how they might affect your personal situation.
Here’s to a beautiful future and a good life!
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