Some Canadians may have a harder time buying a home due to the federal government’s decision to change mortgage rules earlier this month. Here’s a quick overview of all the changes, important dates and what this might mean for the housing market and mortgage rates.
Change #1: Applying a mortgage rate stress test to all insured mortgages
Effective date: Oct. 17
As of Oct. 17, the federal government says “all high-ratio insured homebuyers must qualify for mortgage insurance at an interest rate [that is] the greater of their contract mortgage rate or the Bank of Canada’s conventional five-year fixed posted rate,” which is currently 4.64%.
High-ratio mortgages are those with less than a 20% down payment on the purchase price of a home. The federal government requires homebuyers with less than a 20% down payment to buy mortgage default insurance. In order to qualify for this insurance, the insurer (CMHC, Genworth or Canada Guaranty) calculates the maximum mortgage value they’ll insure using two debt service ratios, which are a measure of the buyer’s debts relative to income, as a proxy for affordability.
Previously, the Bank of Canada rate was used to calculate maximum affordability on fixed-rate terms of less than five years and on all variable rates, while the contracted mortgage rate was used for fixed rate mortgages with terms of five years or more. To put this in perspective, approximately 42% of all mortgage rate requests on RateHub.ca are for five-year fixed-rate mortgages. The lowest advertised five-year fixed mortgage rate on RateHub.ca in Ontario is currently 2.29%, 2.35 percentage points lower than the Bank of Canada qualifying rate.
The federal government says the new rules are intended to keep household debt levels from growing even further. According to Statistics Canada, the country’s debt-to-income ratio hit 167.6% in the second quarter of 2016. That means Canadian households held $1.68 in debt for every dollar of disposable income. And earlier this year, a report from the Office of the Parliamentary Budget Officer noted that “households in Canada have become more indebted than any other G7 country over recent history.”
But the new rules will also prevent some people from getting into the housing market.
“For first-time homebuyers, the stress test for those who need mortgage default insurance will cause them to rethink how much home they can afford to buy,” says Cliff Iverson, president of the Canadian Real Estate Association.
For example, let’s assume a household with an annual income of $100,000 has saved $40,000 for a down payment and they qualify for a mortgage rate of 2.29%. We’ll estimate they have to pay monthly property taxes will be $400 and their monthly heating costs will be $150.
Using RateHub’s mortgage affordability calculator, they’ll only be able to afford a home worth $521,041 or less under the new rules. Under the old rules, they would have been able to spend $635,700—a difference of $114,659.
Change #2: Applying all high-ratio rules to low-ratio portfolio-insured mortgages
Effective date: Nov. 30
The second change introduced by the federal government was not as widely reported, nor as widely understood. This change has to do with bulk mortgage insurance (also known as portfolio insurance).
When a homebuyer has a down payment of less than 20%, they’re required to purchase mortgage default insurance. The buyer pays this premium out of pocket. However, when a buyer has a down payment of 20% or more, the lender has the option to buy insurance on this mortgage, either individually or as part of a bulk buy for multiple low-ratio mortgages. The majority of low-ratio mortgage insurance is portfolio insurance.
Lenders will often group low-ratio mortgages together and purchase portfolio insurance so that they can create low-risk mortgage-backed securities (MBS). The MBS are sold to investors so the lenders can raise funds to lend out more mortgages. The investor is essentially buying a government-backed (insured) loan payout. This is considered a low-risk investment for investors so they’ll accept a lower return. Lenders use MBS as a cheap source of funding for mortgages, resulting in lower mortgage rates.
The new rules
Starting on Nov. 30, these four types of mortgages can no longer be bulk insured:
- Mortgages on rental properties
- Mortgages on properties that cost $1 million or more
- Mortgages with amortizations of more than 25 years
- Mortgage refinances in their entirety
The change for rental properties isn’t expected to have a material impact on the market since they represent a small percentage of mortgages outstanding, but the other types of mortgages are much more common. James Laird, president of mortgage brokerage CanWise Financial (which is owned and operated by RateHub), says 25% to 30% of his business is for mortgage refinances.
It’s common for lenders to take out portfolio insurance on these four popular mortgage products. Both big banks and smaller lenders purchase portfolio insurance, but it’s more prevalent with lenders whose sole line of business is mortgage lending (known as monoline lenders). Monoline lenders don’t typically have access to the same pool of savings deposits that big banks have from their customers. Instead, they sell MBS with portfolio insurance. As a result, the portfolio insurance changes will have the biggest impact on monoline lenders and mortgage brokers who offer monoline products.
Monoline lenders haven’t confirmed whether or not they’ll pause lending on the four types of mortgages outlined above after Nov. 30, which means there’ll be some uncertainty after that date. The big banks can rely on their deposits temporarily but they also depend on funding from MBS. There are many possible outcomes to these changes, two of which are outlined below:
Less competitive mortgage rates and products—Monoline lenders (and mortgage brokers who sell monoline mortgage products) add competition to the mortgage market, which is dominated by big banks. If monoline products are removed from the market, this will likely result in less pricing pressure and higher mortgage rates.
Different mortgage rates for different products—If banks and monoline lenders want to continue to raise funds for the four mortgages types above, they’ll have to do so without government guarantees. And without the guarantees, investors will demand a higher rate of return. These higher rates will likely result in an increase in mortgage rates.
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Flickr: Joe Mabel