April 5, 2019

Anatomy Of Mortgage Changes, Including Government’s Recently Announced Interest-free Loan Program

There’s little doubt housing sales have slowed in the past year, due in large part to stricter mortgage regulations. We’re addressing the evolution of these regulations and their associated changes to help you understand the possible impacts at the consumer level.

The evolution of the mortgage “stress test”

The stress test requires borrowers to qualify for an interest rate that’s at least 200 basis points(2%) higher than their contracted rate. The contract rate is the rate you agree to in your mortgage contract – it’s what your regular mortgage payments are based on. So, prior to qualifying for the mortgage at the contracted rate, your lender has done their own analysis to ensure that you could still make your mortgage payments if your rate increased by 2%.

Those in favour of the stress test saw it as a way to improve housing affordability, thinking it would result in “cooling” house prices in “hot” housing markets like the Greater Toronto and Vancouver areas, and act as a means of 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. Further we believe implementing the stress test in housing markets whose characteristics differ significantly from the GVA and GTA (like Halifax) has had a series of unintended negative consequences – particularly for first time buyers seeking to enter the property ladder.

History

The stress test explained above came into effect in late 2016 for insured loans – “insured loans” meaning those with less than a 20% down payment. The rule changes also saw the elimination of insured refinances.

In January 2018, more changes were introduced, including using the stress test to qualify for uninsured loans – this impacted refinances and purchases with 20% down requiring an amortization of greater than 25 years.

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 (Office of the Superintendent of Financial Institutions – Canada’s financial regulator ), 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 does appear, however, that the government may have overshot its mark with the stress test, and the slowdown in housing sales may have been an unintended consequence. 

Pushback

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

Proposed Solutions

Two ideas emerged from various stakeholders and associations — lower the stress test threshold (currently 2%) and/or reintroduce the 30-year amortization for CMHC insured mortgages.

Government’s 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 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 followers as new information comes top light.

 

You Dream It. We Finance It.