According to a new report by the Mortgage Professionals of Canada (MPC), new stricter mortgage rules are leaving 18 per cent of home buyers out of the market. The MPC report found that while many Canadian home buyers could afford to make monthly payments at the bank’s contract rate, the higher bar set for qualification meant they would have to settle for a smaller mortgage.
Prior to Jan. 1, 2018, the stress test only applied to people with a down payment of less than 20 per cent. However, it now it applies to everyone buying a home, regardless of down payment size. In order to get a mortgage, financial institutions now require all borrowers to qualify at the greater of two options: either the five-year benchmark rate published by the Bank of Canada (currently 5.34 per cent), or the contractual mortgage rate plus two percentage points.
“The stress tests mean that many prospective buyers will have to borrow less than they planned to, and which they can afford,” says MPC Chief Economist Will Dunning, who prepared the report. “They will need to either find more funds for down payments, or buy less expensive properties.”
The MPC report corresponds with another recent study by Royal LePage that found the average peak millennial’s purchasing power in Canada is 16.5 per cent lower than it was at this time last year, meaning they qualify for a mortgage of about $40,000 less than before.
Finding the money for a down payment
Even before the new rules came into effect, buyers were reportedly turning to several different sources to fund home purchases due to the volatility of the national market. Now, stricter rules means home buyers will lean even more on these sources to find the money for the house they want.
The report maintains that while personal savings still fund the majority of down payments (generally covering over one-half of total funds), buyers also look to their RRSPs for support (covering about one-tenth of total funds). The “bank of mom and dad” is also growing in importance, but still accounts for less than one-fifth of total down payments.
Higher interest rates a possibility in near future, making money less accessible
Affordability has also been affected by higher interest rates. The Bank of Canada recently hiked its key interest rate to 1.5 per cent, marking the fourth time rates have gone up over the past year. Overall, the overnight lending rate is up by one percentage point compared to this time last year. This means money is getting more expensive to service.
Dunning also believes mortgages may become even more difficult to obtain due to rising interest rates, but cautions forecasts can be wrong. At this time, he predicts that “the major factors point towards more increases for interest rates: the Canadian and U.S. economies are very strong, resulting in more pressures for inflation, which means that interest rates will tend to rise.”
Outlook on real estate investments
The MPS report finds that most consumers still see real estate as a good investment but “overall strength of consumer sentiment has been weakened by increasing interest rates and the new rules making it harder for homebuyers to secure mortgage financing.”
“Young Canadians remain highly interested in becoming home owners,” Dunning says. “Low interest rates continue to mean that owning is a better deal financially compared to renting. In the past, putting together a down payment has been the biggest challenge. Now, the mortgage stress tests are an added impediment that is pushing home ownership farther out of reach.”
MPC agrees stress test too is too strict for first-timers
The report argues that the stress test, albeit important, is too strict for first-time home buyers in particular. In a press release sent after the report was released, MPC President and CEO Paul Taylor said, “We support a stress test, albeit at a reduced rate of 0.75%, as it is a useful tool to test a borrower’s ability to make future payments.”
He adds, “However, the cumulative impact of rising rates, a two percentage or greater stress test, provincial government rules in Ontario and British Columbia, and further lending restrictions are negatively supressing housing activity not just in Toronto and Vancouver, but throughout the country.”
As this high-interest environment becomes our new reality, Canadians shopping for a home have to be more realistic about what they can now afford. It’s imperative to crunch your numbers, and remember you don’t have to borrow the whole amount the bank offers. By borrowing less, you will automatically save yourself thousands in interest payments. Manage your expectations of the house you are buying. Maybe a smaller home in a different area is the solution.