This is One Beefy Rule Change

OK, how do I put this in a way that doesn’t sound over the top or like fear mongering?

There was this mortgage rule proposal today, and it was a Whopper.

No. Actually, it was larger than that. More like a BK Quad Stacker with extra bacon, cheese and Stacker sauce. It was big.

The potential rules announced this morning were put out for comment by our banking regulator, OSFI. What it’s proposing is that anyone applying for an uninsured mortgage at a federally regulated institution (e.g., bank) prove they can afford a rate that is 200 basis points higher than their actual rate. This watershed rule would take effect this fall.

Why they did it

“The ‘buffer’ of 2% over the contract rate is intended to provide for a straightforward approach for prudently assessing affordability,” said OSFI spokesperson Sylviane Desparois.

The intentions here are good—to ensure folks can make their payments if rates surge.

Moreover, this policy change would finally level the playing field between banks and their competitors (which have had to stress test most customers since last November). Hat tip to OSFI for that as mortgage competition saves Canadians billions in interest.

Necessary…or Not?

I won’t comment on the actual stress test hurdle (200 bps) other than to say it’s totally possible that rates could rise that much. Yet, if that happened, people with equity would still have ample options (refinancing, selling, secondary financing, etc.).

Regardless, if this guideline is ordained it’s going to create as many problems as it does solutions.

For one thing, otherwise well-qualified homeowners will no longer be approved for mortgages they could formerly afford. Think: new doctors, dentists, accountants, engineers, IT professionals, lawyers, etc., who just got out of school, make great money but have university debt. The new stress test will push many of them above debt ratio limits, even though they’d make enough money to pay their mortgage and build a buffer well before rates ever rose 2 points.

Another worry is homeowners with heavy non-mortgage debt loads. Such debt isn’t always due to overspending. Much is the result of layoffs, divorces, illness and other things people can’t control.

For many, it’ll now become considerably harder to roll debt into a mortgage and still qualify. The maximum uninsured mortgage for someone making $70,000 a year, for example, would drop over $80,000. Imagine if you had $80,000 in higher-interest debt that you could no longer consolidate at low rates. Your retirement could be set back by years, maybe a decade. Will these folks thank our federal government for such regulatory “prudence?”

The outcomes are clear. This rule (if approved as proposed) would improve the quality of prime borrowers in this country. It would also take innumerable buyers out of the market for at least 1-3 years, force many into lower-end homes or longer commutes, trap would-be sellers in their homes longer, increase debt-ratio risk for non-prime borrowers and cost millions of blameless debt-burdened consumers untold billions in extra interest.

OSFI needs to think this through (more)—perhaps building in exceptions for those with high credit scores, access to emergency liquidity resources, strong employment and/or ample equity.


Sidebar: Subject to guideline finalization, OSFI’s proposed qualification rate (contractual mortgage rate + 2%) would replace the current one (the Bank of Canada’s benchmark 5-year rate, which is presently 4.64%). It would apply even to non-prime mortgages, 10-year mortgages and those with loan-to-values of 65% or less.

“…The change to the minimum qualification mortgage rate does not apply to insured mortgages,” said Desparois, “which fall under the purview of the Minister of Finance, within the Government of Canada’s mortgage insurance framework.”

 


10 Comments

  • ed says:

    Maybe heavily-indebted people shouldn’t be taking on monster mortgages just to keep up with the Joneses. Home ownership is neither compulsory nor is it a fundamental right. Also, there is a solution out there. It’s called “renting” – you may have heard of it. It happens in other countries. People rent while they save up/pay down debt, until they are in a position to buy a house. I think OSFI is doing the right thing.

  • kd says:

    OSFI’s proposal makes no reference to term or product which implies a 6 month mortgage will face the same 200 bpts qualification threshold as a 5 year fixed. Also by tying the maximum mortgage to a lender’s “contract rate,” a single mortgagor may now face scores, maybe even hundred of different mortgage maximums depending upon the number of rate options considered. I expect there will be all kinds of unintended implications from this change.

    • The Spy says:

      Excellent point KD. Today if a borrower wants a short term and can’t qualify because of the stress test, they choose a longer 5-year term instead.

      If this rule goes through, many wanting longer terms will have to take shorter terms to qualify, and incur more interest rate risk.

  • WayneK says:

    I don’t think anyone wants a big mortgage by choice. Renting is fine for some but there is a reason 7 out of 10 Canadians own. How much equity did renters accumulate in the last 10 years? How much have rents gone up? (hint: a lot) How much non-financial benefit did landowners enjoy versus people who rent? Renting versus owning is never that simple of a decision.

    Listen, if you can’t afford a home that’s one thing, but what OSFI is doing is carpet bombing the market when they should be making surgical strikes at the true risks.

  • Ralph says:

    My Scotia branch manager said they have been using the 4.64 qualifying rate on uninsured mortgages except 5yr fixed.

  • The Spy says:

    @Ralph

    Low-ratio variable and 1-4 year fixed mortgages have been stress tested for a while now at the banks. OSFI is now extending this policy to all terms.

    Up till now, many folks who couldn’t qualify with a shorter term simply took a 5-year fixed instead — since they could qualify at the easier contract rate. That’s about to end.

  • meagan hellman says:

    This Stress Test should/need to apply only to High Ratio
    Debt Applicants who probably shouldn’t be buying a house. Why are uninsured Mtges being penalized in my
    mind from those who have Insured Mtges (CMHC). When
    uninsured mtges usually have the Equity in Home, and
    I find that you get better rates to sell your home, buy
    again, and on your new home pay less than 20% down,
    to get the CMHC Insured mtg, then stress test doesn’t
    apply, you get lower rate, and can make a prepayment
    from the home equity you got selling (-20%- downpayment and apply as a prepayment on new mtg/house. Just a thought?

    • The Spy says:

      Hey Meagan, While theoretically possible, I’ve never seen a case (for a prime residential mortgage) where it made sense to pay a CMHC premium to get a lower rate. There always seems to be a low enough rate elsewhere in the market to avoid that. Moreover, the stress test always applies when getting a CMHC-insured mortgage.

  • maria says:

    I’m looking for refinancing going for variable rate, being
    offered 1.96% 5 yr/25 variable (1.81% cash back of 2345 on 400k) Broker told me 2345 represents diff 1.96-1.81)?
    I’m not liking the push by brokers/banks for Cash Bac k
    financing. Is It good offer, why not forget the cash back
    an give me 1.81% outright. my payments will be based on
    1.96% over 5 yrs, does the cash back over the 5 yrs I’m
    really only paying 1.81. How does that work?

    • The Spy says:

      Hey Maria,

      Brokers would like nothing more than to eradicate cashback rates. They’re a hassle and often more expensive than offering the same rate directly from the lender.

      The problem is, many lenders (including the one you mention) do not allow sufficient rate buydowns. In other words, they don’t let the broker use more of his/her commission to offer you a lower rate. Therefore, a few brokers must give you cash back (in an amount matching the interest cost difference) to make up for it.

      For a $400,000 25-year amortized mortgage at 1.81% effective (with a 1.96% contract rate) you should be getting up to $2,792 in cash back, or a bit less if the broker is using a present value calculation. That’s based on semi-annual compounding. I’m pretty sure the rate you’re quoting has monthly compounding, however. If so, you should get a little over $20 more cash.

      Refer your broker to this post and have them email you his/her cashback calculations.

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