Houses peaked in the Greater Toronto Area in April of this year. Many saw the price gains in excess of 20% year over year to be unsustainable and it was true. When the fundamentals of the economy don’t support the crazy home prices there was bound to be some kind of correction in the prices. Houses are up 20%, but incomes are not. So who’s affording all this?
The hot housing market gave notice to the Canadian financial institution watchdog, also known as OFSI, to take action on the lending practices of Canada’s major lenders. The big 5 banks. If incomes were not rising, how were normal Canadians able to purchase homes at such inflated prices? No doubt there was something that was circumventing the existing rules. Even if foreigners were buying up all the properties, which wasn’t the case as it shows no more than 5% of purchases were foreigners, Canadians were continuing to buy up real estate at alarming rates.
What many people thought were foreigners were indeed regular Canadians that were buying homes. That’s because there are many racial prejudices against minorities when it comes to home buying. When they look Asian, it must be dirty foreign money. A recent Toronto Star article outlined how the majority of Torontonians now consider themselves minorities. That’s not surprising because when you drive around the GTA, the first thing you’ll notice is the diversity of races. So maybe all these buyers were just immigrants or first generation Canadian minorities that just reached adulthood. That foreign buyer fear rhetoric was just good marketing by realtors. Buy now or the Chinese will own everything! Besides, the real statistics show that the majority of foreign buyers are coming from the United States of America. Yeah, no doubt they are trying to run away from President Trump.
Bank of Mom And Dad
Perhaps the most influence in home purchases comes from the previous Boomer generation who have done so well buying homes as an investment vehicle. In fear that their offspring will never be able to get into such a hot Canadian real estate market, many parents have become the de facto lender to the younger generation when purchasing homes. In the summer of 2017, CMHC found that many parents were lending the downpayment to get around the interest rate stress test and the need to carry CMHC insurance on the mortgage. This allowed many people with poor credit, or those that didn’t qualify under the mortgage stress test to get into homes.
Though it seemed like a good idea to encourage young adults to get into the housing market, what they could be setting them up for in the future is a big debt trap. When mortgage rates rise over the next few years, many of these young adults could be strapped for cash when mortgage renewal comes around.
The new changes under the B-20 Guidelines have been announced by OFSI and goes into effect on January 1, 2018. Under the new rules, all home buyers regardless of the downpayment size will now be put under a “stress test” to ensure that they can meet higher mortgage payments. The rule states that all buyers must qualify at the higher interest rate of the Bank of Canada posted 5 year benchmark rate or the contractual mortgage rate plus 2%.
This makes a big difference on the amount of money a purchaser can borrow. Rather than qualifying for a 3.0% 5 year fixed rate mortgage, buyers now have to prove they can pay the mortgage as if the interest rate was 4.8%. Additionally, to close the loophole of people using variable interest rates, the rule states it’s the higher of the Bank of Canada benchmark rate or contractual rate. The current benchmark rate posted is 4.99%. That means if the Bank of Canada benchmark rate is higher than the variable rate plus 2%, then the 4.99% rate applies. What this means is that there is no way for buyers to get around this new rule.
Decreased Buying Power
Come January 1, 2018 home buyers will be faced with the new stress test. This will have a profound impact on housing across the country because it makes homes in expensive areas even less affordable.
Consider this before January 1, 2018:
- A home buyer qualifies for $500,000 mortgage with 20% downpayment so they can qualify for the 5 year 3.0% fixed rate mortgage that banks are offering.
- A mortgage of that amount will equate to $2366 monthly payments if amortized over a 25 year period.
- With a 20% downpayment this means a home buyer can buy a home worth $625,000
After January 1, 2018 with the new “stress test”
- A home buyer will now only qualify for a $407,000 mortgage with the same downpayment as before ($125,000) now that the home buyer must qualify at 5%
- The home buyer will still only pay 3.0% on a 5 year, 25 year amortized mortgage, but now the monthly payments will be $1926 a month
- The total purchase price the home buyer can afford is now $532,000
What the new stress test has done is essentially decreased the buying power of a home buyer. This will severely limit the choices that the home buyer may have and force the individual into a smaller dwelling, or completely pass on buying a home completely. The difference between $625,000 and $532,000 is a staggering 15% drop in purchasing power.
Short Term Rush
What are we going to see in the short term before the end of 2017? A massive rush to close on home purchases. This means there is going to be more competition to get into homes because many other people will try to beat the deadline before their buying power is decreased. This is evident looking at the latest October sales numbers in expensive markets like Toronto and Vancouver. Many will try to push their purchases up to 2017 because it allows them to get into the market before the new rules shuts the door on them.
Other markets in Canada won’t experience the same drastic reduction in buying power because the prices are much lower. A buyer that needs to qualify for $150,000 will only see their qualifying mortgage decrease to $122,000 with the new stress test. Though this represents a higher percentage decrease, the absolute amount is not as high as someone trying to buy in Toronto or Vancouver.
Why? Why? Why?
It might seem unfair that these new rules are being implemented if you are currently looking for a home. However, the government is seeing a housing market that is getting completely unaffordable in places like Calgary, Toronto and Vancouver. Some measures were needed to reduce the risk of individuals defaulting and creating a bad situation for the banks like it did in 2008 in the US. A lot of these rules are not saying that housing is bad, but that the banks are getting too loose on their lending practices and that needed to be changed.
Additionally, it’s been known for quite some time now that interest rates are on the rise. The 5% stress test is needed to ensure that 5 years from now Canadians will be able to continue to pay their mortgages. We all know that wages have not been rising, so it’s important that as interest rates rise, Canadians are still able to pay their mortgages, because the current monthly mortgage payments will never be lower than they are now.
Lastly, a lot of home buyers were circumventing current rules by getting secondary loans from unsecured lenders or parents to purchase homes that were well beyond the reach of their income. These rules are to ensure a level playing field for those that don’t have access to these extra funds. This means everyone now will be buying homes with the same rules put in place and only those that can prove stable income can truly get a mortgage to secure a property.
All of these rules are meant to serve Canadians better. There will be those that will complain that it eliminates them from purchasing a home, but perhaps that’s all for the better if it’s unaffordable. Remember that buying a home is a privilege, not a right.