Will New Mortgage Rules Disrupt the Market?

Home MortgageLast October, the federal government introduced mortgage rules that required anyone needing mortgage insurance (less than 20% down payment) to pass a ‘stress test’ to prove that they could afford the payments if mortgage rates were to increase. The Bank of Canada’s posted rate, approximately 2% higher than the rates actually available, was chosen as the stress level. Following this change, the number of insured mortgages issued by CMHC dropped by 41% over the first three months of this year, suggesting that the new rules were having a big impact on buyers with limited down payments – mostly first timers.

Fast forward to one year later, and the federal government is now making another change to the mortgage rules, and this one may have an even larger impact on the market than any previous rule changes. Effective January 1, 2018, all buyers will have to pass the ‘stress test’ to qualify for a mortgage, regardless of how large their down payment is.

Given that mortgages rates are currently in the 3% range, the requirement to qualify as if the rate were 2% higher is no small thing. For example, let’s consider a buyer who has a down payment of $400,000. Let’s say he can qualify for a mortgage of $800,000 at an interest rate of 3%, and so he afford to buy a house for up to $1,200,000, and his monthly payments would be approximately $3,786.

Now let’s apply the stress test: at a mortgage rate of 5%, the same monthly payments would correspond to a mortgage of about $650,000, so he can now afford a maximum of only $1,050,000, a reduction of about 12.5%. This is not a trivial amount.

Given that more than 50% of mortgages are uninsured (including 100% of mortgages for homes priced over $1 million), and also given that mortgage rates will likely increase further before the end of this year, the new rules may put a crimp into the 2018 spring market. This is especially true for freehold (detached and semi-detached) homes in the high priced Toronto area, for which prices have already dropped about 20% since the ‘bubble peak’ early this year.

The stress test is intended to ensure that buyers will be less likely to default on their mortgages should the market suffer a deep correction. Let’s hope the cure doesn’t end up causing the disease.