Making Sense of the Unsensical: New Government Rules Impacting the Mortgage Industry

October 17 of 2017, our Canadian Government, under the hand of OSFI, made an announcement that had many stakeholders in the Mortgage Industry shaking their heads. We are now 2 weeks into the new B-20 guidelines that will, inevitably, shape the Mortgage market and lending climate for many Canadians looking to buy, refinance or even invest. It’s easy to buy into the rhetoric that these changes are needed to help save the “average” homeowner from themselves. These government policy adjustments were, in their mind, to help curb high household indebtedness and improve affordability. And honestly, it is very easy for most Canadians to agree to this statement. We simply need to look at major city centres like Vancouver and Toronto to see how unaffordable the housing market is and how many are stretched thin because of it. Unfortunately, these changes do little to protect the average home owner.

It’s easy to buy into the rhetoric that the Government is looking out for the little guy. That they are protecting our largest and most costly investment by ensuring each borrower can withstand an interest rate shock – in the event rates go up. And for those mortgage applicants with more than 20% equity in their home, will soon find their borrowing power substantially reduced. And for what reason?

More shocking, is that many of these borrowers will see higher servicing costs than those with only 5% down! Let me state this fact one more time…. if you have 20% down, not only do you have to qualify at your mortgage commitment’s contract rate plus 2%, your interest rate on that loan will be up to .50% higher on average. So, by using this example, an applicant who is purchasing a home for personal use, who has 20% down, long tenure with their employment, good savings (this is assuming we are dealing with a more mature client who has been in the market for a while), will pay more than someone with a 5% down payment. A standard 5 year fixed rate for a low ratio mortgage (non-CMHC insured) is 3.59% whereas a high ratio mortgage (CMHC insured) is 3.19%. That’s a .40% difference. That’s an additional cost of $6,000 over the term.

And it doesn’t stop here! When qualifying, under this same scenario, the low ratio mortgage holder will need to qualify for their mortgage at a rate of 3.59% + 2% or 5.59%, whereas, the same high ratio applicant only needs to qualify at the Canadian benchmark rate which is currently 5.19% (just up from the recent 4.99%). If we are dealing with affordability and if we are attempting to protect borrowers from rising rates, why would an applicant with more equity need to qualify at a higher rate? Even more perplexing, these rule changes do not account for the principle reduction that each borrower will pay over the 5 year term or the market gain that they may realize over the same period. Given this same rate scenario, and an amortization schedule of 25 years, this borrow would realize a reduction in principle of $41,500 – and this is not assuming any accelerated payments which the majority of consumers prefer (bi-weekly payments would equate to a reduction of $49,100). So that same $300,000 mortgage, upon maturity, will carry a new balance of $258,500 or $250,900 respectively. Giving perspective to costs, the original payment amount was $1,508 per month will now be, upon renewal, $1,590 assuming a rate increase from 3.59% to 4.25% (which is closer to pre-2007 rates) and a new amortization schedule of 20 years. That is a modest increase at best and one that shouldn’t have devastating effects upon renewal.

And here’s why:

Canada’s stringent banking policies ensure that all borrowers, at the time of application, do not exceed 44% (if your credit score is above the 680 beacon requirement) of their total income for all debt repayment which includes: mortgage payments, heat, property taxes, and any other outstanding debt payments (it is important to note that any revolving debt facilities are typically calculated at 3% of the outstanding balance and not the minimum). These strict rules ensure that potential borrowers are not maxing out their disposable income to pay for their shelter costs. These rules have prevented a US Housing crash as seen in 2008 – less than .28% mortgage defaults were seen at this time. It also doesn’t account for increase in earnings which should help offset this increase.

What these changes will do is create an environment that could possibly bring to light the very scenario they are wishing to avoid. We are now 2 weeks in under these new rules and these changes are having a profound impact on many. In my opinion, we are stifling one’s ability to achieve home ownership so that they can build wealth, in the form of equity, for themselves. We are forcing people to sell as they can no longer qualify for the home that they have resided in for years (divorce/separation situations take note). And we are forcing people back into an already precarious rental market where rents, at times, far exceed that of a mortgage payment. We are placing further burden on an already burdened market. We have more demand than inventory and that is creating a supply issue. And this goes to the heart of the problem – housing prices are high because demand outweighs supply. If we prevent people from moving beyond the rental market, then we are reducing supply there to. This in turn, will place pressure on rental values. We have already seen it. People paying more to rent than what it would cost to buy. The housing market is cyclical and tends to correct itself when conditions change. Bad Government policy will only make conditions worse.

This is why we cannot make sense of the unsensical – it simply doesn’t make sense. All we can do now is find solutions to help all borrowers realize the potential in home ownership. Building wealth is not isolated to the wealthy. You just need a good team of professionals that can help provide guidance and options when solutions seem bleak.