October 17, 2017
BREAKING NEWS from OSFI (Canadian mortgage and banking regulator):
Background, Commentary and Impact:
OSFI (Office of the Superintendent of Financial Institutions) is Canada’s federal banking and mortgage financial regulator, and its mandate is to protect the overall stability of the financial system. Their goal is to prevent a financial crisis that our southern neighbours observed almost 10 years ago.
Today’s announcement creates a new stress test for borrowers who have a down payment of 20% or more, effective January 1, 2018. Stress test is a fancy term which means that borrowers can now borrow less money. OSFI created this stress test because they are worried that borrowers are qualifying for low mortgage rates today, but they won’t be able to afford their mortgage if the rates rise in 5 years. It is important to remember that OSFI’s mandate includes all of Canada, not just Toronto and Vancouver…
What is the new stress test?
In the past, a borrower with a down payment of 20% or more needed to ‘prove’ they could afford to pay the mortgage at the 5-year fixed rate (eg. 2.99%). This new rule means the borrower must prove they can afford the mortgage at the greater of
-The 5-year fixed rate (eg. 2.99%) PLUS a ‘cushion’ of an additional 2.00%
-The benchmark rate (currently 4.89%)
Imagine a married couple making $150,000 per year who purchases a house for $1.3 million with 20% down payment ($260,000). In the past, the banks would approve this mortgage of $1,040,000. After today’s stress test, these same borrowers can only borrow $790,000. Given the down payment is still $260,000 – their maximum purchase price has decreased to $1,050,000 or by $250,000.
What does this mean for the real estate market?
OSFI created the stress test with good intentions, but it could have unintended consequences and actually add risk to the financial markets, and further cool the real estate market. Consider the cumulative impact of recent government intervention:
-Foreign buyer’s tax
-Two interest rate increases by the Bank of Canada
-New stress test (per above)
-Upcoming changes to the tax code further reducing liquidity/profitability (eg. Corporations)
The real estate market is like a campfire. You definitely don’t want an inferno, however if you keep pouring water on it, the flame will be extinguished. Although OSFI wants to protect the financial system, this new change represents another bucket of cold water on a real estate fire that has already cooled significantly.
Does this stress test even make sense?
It is arguable whether this change will reduce or increase risk, and whether the risk is actually significant. Consider the following:
-Most people will be earning more money in 5 years (due to promotions, inflation, etc)
-In 5 years, a borrower has paid off a chunk of his mortgage principal, so when he renews, even if rates are higher, he is borrowing less money. For example, even if rates increase from 2.99% to 4.99% in 5 years, the borrower is only paying $560 more per month. Is it likely that this married couple who is currently making $150,000 will be making $6,720 more per year (in after-tax dollars)? Almost certainly. And if they are not, they can refinance to reduce their monthly payments.
-The new stress test means that some borrowers will need to find lenders who can ‘stretch’ their lending guidelines, meaning they will pay a higher mortgage interest rate, further adding risk and also hurting consumers. That extra interest cost was money which could have been used by the borrower to make lump-sum payments to further reduce the mortgage size
-The new stress test will not apply to mortgage renewals, meaning a borrower with a $500,000 mortgage and $25,000 in credit card debt may not be able to refinance for a new $525,000 mortgage, even if it means their monthly payment and interest costs are lower. Plus, the bank may not be generous with their renewal terms, since many borrowers will have no choice but to stay with their current lender
So now what?
In summary, I expect these changes to have a material impact on mortgage lending, and it will ultimately create headwinds for the real estate market. Some buyers might rush to buy now to avoid the rules, so real estate may experience a short uptick in volume and prices. These changes are effective in the new year, so it will be interesting to see when the impact is felt. In the meantime, if you have questions about refinancing, renewing or a new purchase, speak with your mortgage professional as soon as possible.
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Elan Weintraub earned his BBA and MBA from the Schulich School of Business, where he graduated in the top 3% of his graduating class. He is a director and mortgage broker at Mortgage Outlet, one of the “Top 75 Mortgage Brokerages in Canada” according to Canadian Mortgage Professional Magazine. Elan has delivered numerous mortgage seminars at the Toronto Real Estate Board, real estate brokerages and to investor clients and works with clients ranging from first-time buyers to new-to-Canada to bruised credit to sophisticated investors and commercial/construction projects.
Elan Weintraub, BBA, MBA
Mortgage Outlet Inc