Note: There have been changes to the mortgage stress test may affect the relevance of this article.
It’s been an interesting year for homeowners and prospective homeowners in Canada. Interest rates are on the downswing while housing prices are staying relatively stagnant. In my opinion, this is about as good of a buyer’s market as you’re going to get, outside of some heavily priced areas such as Vancouver and the GTA.
However, a little but not so little rule was put in place that is drastically changing the real estate landscape for both first-time homebuyers and buyers looking to sell their current home to upgrade.
Compare today's top mortgage rates
OSFI’s Mortgage Stress Test
The current benchmark rate for Canadian mortgages sits at 5.34%. For those who are unaware of what this means, this is the rate that you must qualify for, or in simpler terms, be able to afford the payments of the mortgage at.
The rule was put in place for a couple of reasons. The primary goal with the implementation of the mortgage stress test was to reduce overall consumer debt. However, it was put in place to also cool down the rapid acceleration of real estate markets in areas like Vancouver and Toronto.
My girlfriend and I are in the final stages of acquiring a new home. This is my first experience purchasing a home in the stress test era, as my two current properties were purchased pre-stress test. It was an interesting endeavor, no doubt, and I’m here to explain some significant effects this test, which doesn’t appear to be going anywhere anytime soon, has on buyers.
Compare today's top mortgage rates
When looking to pre-qualify yourself, use the benchmark
While I heavily object to it, a lot of homeowners tend to qualify themselves. What I mean by this is instead of heading to a bank and seeing what kind of financing they could get, they simply head to a website like Ratehub to check out interest rates and calculate mortgage payments.
From there, they plug in the rate they’d hope to get, see how much the mortgage payment is and judge if they would be able to afford it. I’ve known buyers who were well within their means, so they didn’t even bother to get pre-qualified before making an offer on a home they wanted.
You can still do this today, but it is super important that you don’t plug in the lowest interest rate you think you could get via financing. The benchmark is currently 5.34%, which means no matter how low your official interest rate would be, you must be able to afford that home at 5.34%.
Using Ratehub’s mortgage payment calculator, we can see that the payment on a $300,000 home with 10% down is $1,356 a month at a rate of 3.29%.
However, the payment the banks will require you to be able to afford is $1,673 a month, which comes from the 5.34% benchmark. That’s a difference of 23.3% every single month in payments. It’s important to note, though, that this is just the rate at which you would need to qualify. You still pay the rate you are contracted by the lender.
The home we are finalizing right now had a sale fall through due to financing conditions not being met. This may have been the end result of someone not taking into account this benchmark.
This has significantly reduced the amount of buying power prospective homeowners have
Unlike CMHC fees, which are insurance payments you need to make if you put less than 20% down on a home, the stress-test applies to every single mortgage provided by federally-regulated lenders. This wasn’t always the case, but was put in place in early 2018.
If your qualifying payment is 23.3% higher than your actual mortgage payment, you are essentially losing 23.3% of your buying power. As a result, a person who would have been approved for a $400,000 mortgage pre-stress test would only be able to qualify for $306,800 now.
In some areas, particularly large urban cities, this price difference can mean going from a detached dwelling to a duplex or possibly even a condominium. It’s extensive, and it’s having a substantial effect on the housing market, particularly in Western Canadian provinces, where the economy is generally struggling due to a sluggish oil and gas sector.
As per this article from Global News, you’re going to need to make nearly a six figure income to qualify for the average cost of a home in Calgary. For Vancouver? Over $216 000 a year.
Compare today's top mortgage rates
What about renewing your mortgage?
It’s a well-known strategy that once your mortgage is expiring, you attempt to shop around and try and find the best rate. Buyers typically lock in to five year fixed or variable rate. It gives them the flexibility to explore options down the line and get the best deal for themselves.
However, those who received a mortgage just before the stress test was put into place may find this money saving strategy stripped away from their arsenal. Why?
It’s simple. Lenders do not have to apply a stress test to current borrowers renewing their mortgage with the same institution. But if you’re looking to shop around, a new lender will have to apply the same fundamental requirements that are needed for an initial buyer, which includes qualifying for the current benchmark rate that is set.
This means if you could afford that $400,000 home and did so prior to the stress test, if you’re mortgaged amount isn’t lower than the $306,800 you’d be qualified for today, you might be at your current lenders mercy and ultimately their interest rates offered. Still, it’s a good idea to speak with a mortgage broker to try to get the best Alberta mortgage rate, to learn about the best mortgage rates in BC, inquire about the best mortgage rates in Ontario – or whichever province you currently own a home in.
How does the stress test affect sellers?
Like most things in life, the real estate market is highly dependant on supply and demand. Much like a commodity such as oil, if the demand is low the prices will ultimately drop.
The new stress test has priced a lot of Canadian homebuyers out of the market. For those who are looking to get into a starter home, they may be willing to sacrifice their dreams of a detached single-family dwelling for a condominium or townhome. But for those families with children or dependents who need the space, it has ultimately left them with two choices:
- Stay in the home they have now and continue to rent or pay the mortgage.
- Save more for the down payment.
This is having a ripple effect on the housing market, particularly in the western provinces where this newly implemented rule has put an already struggling market into even tougher circumstances.
Dan Kent is the co-owner of Stocktrades.ca. An active dividend and growth investor, his pieces have numerous mentions on the Globe and Mail, Forbes, Winnipeg Free Press, and other high authority financial websites. He has become an authority figure in the Canadian finance niche, primarily due to his attention to detail and overall dedication to achieving the highest returns on his investments. Investing on his own since he was 19 years old, Dan has compiled the experience and knowledge needed to be successful in the world of self-directed investing, and is always happy to bring that knowledge to Stocktrades.ca readers and any other publications that give him the opportunity to write. Dan manages his TFSA, RRSPs and a LIRA at Questrade, and has compiled a real estate portfolio of his primary residence and 2 rental properties, all before his 30th birthday.