Recent changes may be good news for homebuyers

We’ve had back-to-back changes recently in the mortgage world – one direct, one indirect. The benchmark rate used to qualify will change downwards starting April 6, 2020, and the Bank of Canada (BoC) just cut its key lending rate from 1.75% to 1.25%.

Two years ago, the stress test was introduced as a safeguard against rising interest rates, to make sure homebuyers would still be able to make their mortgage payments if their rate increased. To qualify for a mortgage, buyers need to qualify at the greater of 2% higher than the contract rate or the Bank of Canada’s average 5-year rate, which today is 5.19%.

Earlier this month, Minister of Finance, Bill Morneau, announced changes to the benchmark rate used to determine the qualifying rate for insured mortgages – mortgages with less than 20% down payment. This change will come into effect on April 6, 2020.

There has been mixed response from the financial community about this change. For some, the new qualifying rate will make it more affordable; for others, it won’t make much of a difference, especially in hot-market areas, where prices are rising quickly.

Then, on Wednesday, March 4, 2020, the BoC cut its key lending rate by 50 basis points, from 1.75% to 1.25%, which had an almost immediate effect on lines of credit and variable-rate mortgages -- banks dropped their prime rate from 3.95% to 3.45%.

This means that borrowing costs for mortgages, auto loans and other lines of credit are set to head lower. Consider a $400,000 mortgage on a 2.95% variable rate. The mortgage rate would shift to 2.45%, and mean about $100 per month in savings.

Why is this happening?

The interest rate drop comes on the heels of the US Federal Reserve’s decision to lower its rate by .50 points due to the global economic challenge posed by the uncertainty of the coronavirus that will likely affect domestic spending. The BoC’s rate cut of the same percentage took many by surprise – it was expected that rate would drop a quarter of a percentage.

There were also other yellow alerts prior to the coronavirus – a drop in global equity markets and in oil prices, created uncertainty in the financial markets. It wasn’t a stretch to think that the same drop in confidence would hit consumers as well. The BoC does not want to jeopardize domestic growth.

With regard to the stress test, there has been pushback from some economists and housing experts who say that the new stress test will just further fuel the housing market.

Here’s what we know about the stress test

• Currently, the stress test for insured mortgages is 5.19% (the minimum rate at which homebuyers must qualify, no matter the actual contract rate.)
• The new stress test, if it was in place today, would be approximately 4.89%.
• The Big Banks will no longer determine the stress test rate. This is good news. Banks have been hesitant to cut their-five-year posted rates (which the stress test is based on). This has made it more challenging for borrowers to qualify for a mortgage.
• Borrower’s will have slightly more purchasing power

Here’s what we don’t know

• How it will affect the average buyer. This will depend on a variety of factors, including the location of the property being purchased. In smaller markets, the new benchmark could help affordability for some buyers – in larger markets such as Vancouver or Toronto, it may have little effect.
• If it will affect home prices. More consumers qualifying for a mortgage may increase demand and put upward pressure on prices – there is still a shortage of properties available for sale.
• The new benchmark calculation, as stated, is more flexible. If interest rates continue to fall, then, in many cases, buying power would also increase.

As always, time will tell how all this will play out and there is talk that the BoC will cut the rate at least once more this year.

What does this mean for fixed versus variable-rate mortgages?

Fixed rates are priced on the bond market, which have fallen quite dramatically since January, so it’s likely that fixed rates will continue to move lower.  Now, with the BoC rate cut, and the banks following suit by dropping their prime rate, variable-rate mortgages will also drop.

Many factors go into deciding whether to choose a fixed or variable mortgage, and it’s a topic to discuss with your mortgage professional.

For now, these changes could be good news for homebuyers.

The Ongoing Stress Test Debate

By Mark Kerzner,
President, TMG The Mortgage Group

The controversy over the mortgage stress test continues. Banks, economists, mortgage lenders, Realtors, mortgage brokers, and its association Mortgage Professionals Canada (MPC) are urging government to make some changes, not to get rid of the stress test altogether, but to consider some variables, such as income growth and mortgage repayment which may not have been factored in.

So it was curious to hear Evan Siddall, CEO of Canada Mortgage and Housing Corporation (CMHC), imploring the Standing Committee on Finance to “..look past the plain self-interest of [mortgage brokers]… Apparently, the MPC [Mortgage Professionals Canada] is content to see home builders, real estate agents and mortgage brokers receive short term benefits while Canadians bear the long-term costs.” 

I am not sure where this personal attack is coming from or how this advances his agenda. As an industry we have provided a valuable sounding board and meaningful suggestions for tweaking rule changes to ensure a healthy and stable housing market today, and for the future.

When many industry experts support the position that a stress test could consider other factors such as principal repayment and income growth, for example – and such support also coming from very credible bank economists -- some of whose employers choose not to deal with brokers directly-, then it's uncertain why Siddall would personally attack an Association  representing the broker channel.
In addition, the Chief Economist of MPC, Will Dunning, just published a report further detailing reasons why the stress test should to be tweaked, along with market commentary by various economists and their positions on the subject.

The stress test was introduced without consultation from industry insiders and stakeholders and now the Government has a locked-in position they seem unwilling to change. The stress test is having a negative impact on the housing market and could very well affect the economy in the long term.
However, the story is not one side advocating for the all-out removal of stress tests against the other side locking into an unchangeable position.

Let’s look at the entire story. When the February 2010 stress test was introduced on mortgage terms less than 5 years, and on variable-rate products, it was done seemingly to protect a consumer’s ability to handle payments in an increasing rate environment at the time of renewal.

This time around it appeared as though the stress test was introduced for different reasons. The overall amount of sovereign debt was considered too high as it approached $700 billion.  There was concern about runaway prices in Toronto and Vancouver.

However, the stress tests introduced in October of 2016 by CMHC and then extended to conventional mortgages by the Office of the Superintendent of Financial Institutions (OSFI) in January 2018, was ostensibly to reduce future debt burdens. 

The result has kept an estimated 40,000 would-be homebuyers on the outside looking in, according to an April TD Report.  According to the Globe and Mail “The government [was] responding to concerns that sharp rises in house prices in cities like Toronto and Vancouver could increase the risk of defaults in the future should mortgage rates rise.”

From my perspective, if we are going to be heavily relying on a Benchmark rate in qualifying applicants, then the way the Benchmark rate is determined should also be changed.

It is currently set from the mode of the big banks’ posted rates. It should be determined either by a market-driven rate (perhaps as a delta to bond yields), have an established floor (say 4.25% for example) or relate specifically to the contract rate itself.

We have seen interest rates drop over the first two quarters of 2019, yet bank posted rates and the stress test have not. As interest rates were rising last year the banks chose to increase their posted rates, and the Benchmark rate was correspondingly increased. 

When the 2016 stress tests were introduced, the Benchmark rate on which it was calculated was 4.64%.  At the same time the discounted 5-year fixed rates were in the 3.69% to 3.99% range. Today, 5-year fixed rates can be found in the 2.89 to 3.19% range and the Benchmark rate is 5.34%.
For clients renewing their mortgages AND who have made their contractual payments as agreed, to qualify them at a rate higher than their contract rate if they want to transfer their mortgage is simply anti-competitive.

The mortgage industry supports high underwriting standards to ensure a buffer exists in our collective ability to withstand higher interest rates.

Instead of creating animosity and adversity, let’s work together to create an environment that encourages qualified and responsible First Time Homebuyers in accessing the market.

If you are a mortgage customer looking to access the market make sure to use the services of a mortgage broker who can help you navigate the rules, options and opportunities to align with your long term goals and objectives.

Anatomy of mortgage changes

There is little doubt that housing sales have slowed down in the past year, due in large part to stricter mortgage regulations. Part of those regulations is a mortgage stress test that requires borrowers to qualify for an interest rate that’s at least 200 basis points higher than the contracted rate. 

 Those in favour of the stress test saw it as a way to improve housing affordability by thinking it would result in falling home prices, as well as protecting homeowners from potentially higher interest rates at renewal.

While there were some house price reductions, there was also a major slowdown in house sales, which, one could argue, has helped fuel a slowing economy. 

History

The most recent round of mortgage rule changes came into effect in 2016, then in January 2018, more changes were introduced, including using the stress test to qualify for uninsured loans.  This had the greatest impact.   The next month, in February, sales declined in greater Toronto by 35% from those recorded in February 2017.  This past month (February, 2019) housing sales in greater Toronto were even 2.4% lower than a year ago. 

Housing sales in greater Vancouver were even weaker, with February 2019 sales 33% lower than the same month in 2018. In fact, February 2019 sales are 43% lower than the 10-year average for sales in February.

Evan Siddall, who heads Canada Mortgage and Housing Corporation (CMHC), believes the stress test is bitter medicine that is working fine. Siddall credits the stress test for lowering housing prices. His comments were based on the stress test being introduced to lower housing prices; however, Carolyn Rogers, the Assistant Superintendent at OSFI, said something different in her speech to the Economic Club of Canada.

She explained, the stress test “was designed to target mortgage underwriting standards.” In her words, the test was intended to provide a safety buffer so that borrowers do not “stretch their borrowing capacity to its maximum.”

Is it plausible that OSFI and the CMHC had two different goals? Maybe.  OSFI’s goal did indeed lower high-risk lending somewhat as reported by the Bank of Canada. House prices did drop slightly.

It appears the government may have overshot its mark with the stress test, and the slowdown in the housing sales may have been an unintended consequence. 

Pushback

Many housing and mortgage industry voices started to lobby the government -- some believed the stress test was working fine, other’s say the impact has been devastating to home buyers, especially first-time homebuyers.

CIBC economists, Bejamin Tal and Royce Mendes predicted in November, 2018 that the housing market would be a drag on Canada's economic growth in the coming year. Residential investment accounts for 7.5% of Canada's economy.

"It was a good run while it lasted, but the sun has officially set on the days of heady housing market growth fuelling Canada's national economy," Tal and Mendes wrote. “And that could be bad news because housing investment is more important to Canada's economy "than at any other time on record," they added.

Proposed solutions

Two ideas emerged from various stakeholders and associations -- lower the stress test threshold that requires borrowers to qualify at least 200 basis points above the contracted rate; and/or reintroduce the 30-year amortization for CMHC insured mortgages.

Government response

The Liberal government introduced the following two measures in their recent budget announcement to address the issue of housing affordability and first-time home buyers.

Home Buyer’s Plan Withdrawal Increase. Effective immediately, first time home buyers can now withdraw up to $35,000 from their RRSP, tax free, up from $25,000, for a down payment. If you have a co-borrower, that total could be up to $70,000. 

A first-time homebuyer, as defined by the Canada Revenue Agency, allows repeat homebuyers to also be classified as “first-time” if they or their spouse haven’t occupied a home, they owned in the prior four years. 

Funds must be repaid over a 15-year period or the money gets added to your income for tax purposes. Starting in 2020, those who separate from a spouse or common-law partner will get to use the Plan, even if they’re not a first-time buyer.

First Time Home Buyer Incentive

Billed as a “shared equity mortgage”, the government will lend first-time home buyers’ money to buy a home. According to the budget document, this new incentive “enables homebuyers to reduce the amount of money required from an insured mortgage without increasing the amount they must save for a down payment.”

The government has earmarked $1.25 billion over three years, administered by Canada Mortgage and Housing Corp. (CMHC), to provide up to  5 % of the cost of an existing home and 10% of a new home through what amounts to an interest-free loan to be repaid when the property is sold. 

Key points: 

•  Borrowers must have a down payment of at least 5% -- but less than 20% -- and a household income under $120,000.
•  The insured mortgage plus incentive, combined, cannot be greater than four times the participants’ combined annual household incomes.
• Condo purchases are allowed.
• The program is expected to start in September 2019 with further details to come this year. 
•  If you use it, the government will share in price gains or losses when you sell. (The government hasn’t released many details on this yet) 
• While the Department of Finance has not commented on this, the program is called a “shared equity mortgage”, so it may be safe to assume it will be a registered second.
•  You must be a first-time homebuyer. (We don’t know whether the government’s definition of “first-time buyer” will be the same as with its RRSP Home Buyers’ Plan (see definition above)
• Your mortgage must be default insured. Buyers may use any of the three insurers.
• There are no monthly payments required on this incentive money
• You have to pay the money back when you sell your home. There was no mention of what happens during a refinance but if similar programs abroad are any guide, a cash-out refi would trigger the repayment provision. 

Aftermath

Paul Taylor, CEO of Mortgage Professionals Canada, which represents the mortgage-brokerage channel, said in an interview with the Globe and Mail, he is disappointed that the government did not heed his organization’s calls to reduce the stress-test burden, which is keeping many home buyers from qualifying for mortgages.

But he said the new interest-free loan program will help the earners most affected by the stress test, so it may be a good alternative. The program requires more analysis to assess how successful it will be, he said.

His organization estimated that the stress test would compel about 200,000 potential home buyers to change their plans in the first two years of operation. If 100,000 are helped by the loan program over three years, “a good chunk” of people most impacted may be getting help, he said.

Many other key details, including precise repayment terms and maximum available loans, have yet to be addressed.  The government says CMHC will release full details later this year. That’s a long time, politically speaking and things could change again, given it’s an election year.

We will continue to monitor these announcements and update our readers as new information comes top light.

Consider getting pre-approved before January 1, 2018

There is not a lot of time left. New home buyers may want to consider getting a pre-approval before the new rules come into effect on January 1, 2018. Some lenders have already implemented the new rules, which includes a stress test,  that will affect homebuyers with down payments of 20% or more.

Armed with a pre-approval, you may be able to purchase a home before the expiry date – usually 120 days –  and won’t be affected by the new rules. Many buyers are getting ahead of the new year.

According to statistics released on December 14 by The Canadian Real Estate Association (CREA), national home sales rose strongly in November 2017.

Highlights:

•  National home sales rose 3.9% from October to November.
• The number of newly listed homes climbed 3.5% from October to November.
• The MLS^® Home Price Index (HPI) was up 9.3% year-over-year (year-over-year) in November 2017.
•  The national average sale price edged up 2.9% year-over-year in November.

Home sales via Canadian MLS^® Systems rose for the fourth month in a row in November 2017, up 3.9% from October. Led by a 16% jump in sales in the Greater Toronto Area (GTA), the surge in sales there accounted for more than two-thirds of the national increase. The continuing rebound put November sales activity a little over halfway between the peak recorded in March 2017 and the low reached in July.

 “Some home buyers with more than a twenty percent down payment may be fast-tracking their purchase decision in order to beat the tougher mortgage qualifications test coming into effect next year,” said CREA President Andrew Peck.

“National sales momentum remains positive heading toward year-end,” said Gregory Klump, CREA’s Chief Economist. “It remains to be seen whether stronger momentum now will mean weaker activity early next year once new mortgage regulations take effect beginning on New Year’s day.”

Let’s Review

The new rules apply to federally regulated financial institutions, not credit unions or private lenders. Yet.

Insured Mortgages

This is a mortgage transaction where the default insurance premium is paid by the client, as is typical in a high-ratio mortgage, meaning with less than 20% down.

Insurable

This type of mortgage can now be considered the new “insured mortgage”. These are still eligible for default insurance but is portfolio-insured at the lender’s expense or high-ratio insured at the client’s expense. There are tougher rules as well – the maximum amortization is 25 years, applicants must qualify at the Benchmark rate and property must be valued at less than $1M. Property must also be owner-occupied.

Un-Insurable

These mortgages are not eligible for default insurance and apply to refinances, rental properties, stated income, and on purchases greater than $1M.

All uninsured mortgages are subject to a new qualifying rate, as of January 1, 2018, or stress test. This rate is the Bank of Canada’s five-year rate, currently at 4.99%, or the lender’s contract rate plus 2% --whichever is greater. Your mortgage payment will still be based on the contractual mortgage rate but the higher rate will be used for qualifying purposes.

Which mortgage is best for me?

That depends. Every situation is unique. There are pros and cons for each of the three types of mortgages, depending on your financial goals.  For example, sometimes the spread between the insurable and un-insurable rate is significantly large enough to justify the borrower paying high-ratio mortgage insurance to obtain the lower rate.

A mortgage professional can explain the differences and give you the best advice and get you best interest rate.

So, start with a pre-approval.  Call your TMG mortgage professional today.