Changes to Mortgage Rules in 2018
There truly is never a dull moment in real estate these days. We’ve all heard about the great enthusiasm and commotion out there on the market. Whether it’s the sizzling hot Greater Toronto Area, or the rapid expansion of our own Kitchener-Waterloo, there seems to be a lot going on.
So much so that it has prompted a reaction from officials who are concerned about the stability of the market environment. Over the course of the coming year we’re going to see a few important changes to the landscape.
The Old Mortgage Rules
Let’s take a look first at the old rules, which are currently still in effect until the end of the year. Under the old rules, a borrower would have to put together a downpayment amounting somewhere between 5% and 20% of the total value of the property.
The remaining sum would be left to be amortized with interest over a period of 25 years. After these numbers are figured out, there are additional criteria taken into account regarding the borrower’s income, as well as the amount of debt payments they have to make.
This is all to try to assess if the mortgage payments are something the borrower can afford. In addition to all of the above, for mortgages under the 20% mark for downpayment, there is a requirement to obtain mortgage insurance.
This insurance protects the lender in the event that the borrower cannot keep making payments and abandons their commitment to the loan.
The reasoning is that the more money a borrower puts down, the more purchasing power they show, while also leaving less money to be paid back over the course of the loan.
Similarly, the less they put down, the more money is left outstanding and the riskier the entire deal becomes. This is why it has become a requirement to insure certain mortgages.
It’s worth mentioning that there is quite a bureaucratic structure in place to facilitate this safety net, however it ultimately gets backed up by the federal government.
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This means that the burden from the riskier mortgages out there sits on top of a pool of taxpayers’ money. The arrangement overall does go to benefit both lenders and borrowers at the end of the day, however, we can see why people should be cautious when managing said (olympic sized) pool of taxpayers’ money.
The New Rules Starting in 2018
The new regulations bring to the forefront something called a stress test. This stress test was reserved only for the high-risk borrowers with downpayments under 20%, however now it will become mandatory for everyone out there.
The stress test lives up to it’s name in that it is an examination of sorts, and it definitely can be stressful. The idea is that people’s loans are assessed at the regular going rate, and they will ultimately be paying that rate, however there is an additional assessment done at a threshold above the current rate.
So, say you figure out a mortgage for about 3.5% and qualify for it. The stress test will then try to qualify you for a rate above that 3.5% and you are expected to pass it.
If all goes well, you will still end up paying the initial 3.5%, however it is necessary that you can also hypothetically withstand a higher rate as well. With the current regulations, the stress test that everyone is facing could be up to 2% higher than the going market rate.
Why would you be tested for a rate that you will not end up paying? The reasoning is that it introduces a margin of safety. Interest rates vary and market conditions are always subject to change.
It’s never out of the question that rates can go up for a variety of reasons. Until now, most people were tested without any margin of error, leaving them vulnerable in case of a market shift.
Given how abuzz the real estate market is and how many sizeable loans are taken out each year, it can be quite scary to think that there is no elbowroom in these calculations if the market were to shift.
There are some additional considerations as well. With all types of mortgages, lenders will calculate something called the debt ratio. The debt ratio reveals how much of your income is spent paying off debts.
This is because the more outstanding loans someone has, the riskier it becomes to lend out more money to that individual. At the same time, it can definitely put a damper on someone’s quality of life if the bulk of their income is taken up by debt payments.
Even if they get an impressive home out of it, it’s certainly not wise to commit to something like that for what can amount to decades. Therefore, for reasons both financial and ethical, lenders look at this debt ratio.
Upon figuring it out, they also introduce the calculated mortgage payment as well as additional costs that come with home ownership. These include a miscellany of costs such as insurance and even utilities.
When all of this is added up, the total sum is divided by your income and is called the total debt ratio.
This total debt ratio must under all circumstances be lower than a specific threshold. This always has been part of mortgage calculations, however, with the new rules we will be looking at lower (and therefore more stringent) thresholds for qualifying.
All of the above represent a much more cautious attitude coming from officials. The stress test better prepares people for market changes, while the lower debt thresholds ensure that debt payments don’t overwhelm people’s incomes.
The question that comes to mind at this point is: why the change of heart? It feels a little bit unfair that hardworking home buyers are treated with such strictness just because a handful of people out there happen to be risky to deal with.
The tricky thing with financing of all kinds is that it is all interconnected. Lenders extend funds from their reserves to borrowers and calculate when they can receive that money back so that they may lend it to others as well.
In turn, other borrowers count on the lender to be able to provide funds when they need them. Therefore, if a borrower fails to pay back their loan and defaults on their commitment, it puts everyone down the line at risk.
This burden naturally is dealt with by the lender, but we can see why they would want to minimize their risk. At the same time, while this is quite the oversimplified view, the same idea was at play during the 2008 housing market crash.
Many people were qualified for mortgages which in truth they could not afford. This was done on such a scale that when people did start to default, the economic consequences were staggering. All of this boils down to the simple process of qualifying a borrower with due diligence.
Looking back at what has happened, as well as the rapidly accelerating housing market in Canada, it’s no surprise that officials are looking to create a bit of elbowroom when it comes to the interest rate.
It’s been said that while it is an inconvenience now, it definitely is something we will be benefiting from in the long run with a more stable housing market.
The Market Impact
While that does provide quite a bit of context, we do need to get to the bottom line. How does this affect buyers? First and foremost, buyers who qualify will be getting smaller loan amounts for their mortgages, therefore reducing their purchasing power.
At the same time, there are buyers who would have qualified under the old rules, but now would not be able to get a mortgage at all.
This is a drop of sad news for first time home buyers as it can make the difference between being able to make that move or not.
For current homeowners, they will be feeling the effects of a change in home prices. Looking into 2018, we can see that qualified buyers will have less purchasing power than they have this year, while also having some potential buyers excluded altogether by the stricter rules.
This means that there will be less buyers on the market, and those buyers’ budgets will also be smaller. Quite a statement to make given all that has happened this year! Does this mean that house prices will plummet?
Should we be panicking? Absolutely not, but we will be seeing less volatile growth on this front, which in the long run will actually be beneficial.
All in all, through the laws of supply and demand we will see a drop in house prices as there will be less excitement and purchasing power coming from buyers (up to 15% less in some cases).
We can keep expecting homes to be well priced, relatively speaking, as we are sitting at the peak of a long standing growth trend, however our outlook for the future will be more even tempered than the tumultuous year we’ve had so far.
Earlier in the Year
We can remember earlier in the year when there were some changes announced to policies regarding investment and rental properties.
This was done in an effort to reduce possible over inflation of prices. To recap very briefly, one of the focuses was levying a tax on foreign investors who are buying up real estate.
Why the sudden cold shoulder to potential investors? It all comes back to supply and demand. Because real estate is very fixed in nature, there could be issues with supply shortage if a lot of people flock in to buy up properties.
Simply put, it’s not so easy to just produce more real estate (as you would produce any other products). This means that, with supply falling behind, the influx of investors (as is the case with the GTA) was contributing to the increase in prices of homes.
The concern was caused by the fact that local residents might be outbid by aggressive business people, and consequently left out.
This concern gets compounded when you consider that these properties would ultimately be rented out back to the same local residents.
While you can’t say that it’s the worst, it’s certainly not ideal to have to rent a property instead of making payments and ultimately owning that same property. When it came down to managing our local real estate, the government opted to try to slow down the investors in order to help favour local residents.
It’s worth noting that the effort isn’t to stop investment, as that would actually be quite the loss. However, it is in an attempt to cool it slightly and level the playing field, so to speak.
That was the excitement earlier in the year, so let’s fast forward to today’s grand reveal. The news has already spread like wildfire that we are facing tighter mortgage thresholds and more stringent lending rules starting on January 1 2018.
That’s quite a way to ring in the new year!
A Time to Make Decisions
One last point to factor in is that, while we are looking at some changes, 2017 will not be going down without a fight. With the new rules starting on January 1 2018, this means that the old rules are still in effect for now.
With people being well aware of the upcoming market conditions, we’re likely to see a flurry of activity in the last stretch of this year.
Sellers will want to get on the market sooner rather than later, and buyers will try to qualify before the end of the year.
We can expect to see a lot of people hitting the market and a fair amount of properties exchanging hands. That being said, it’s a good time right now to make decisions regarding real estate.
If you want to sell and cash out on the appreciation of your home, now is the time. If you want to get in and buy a new property, now is also the time.
Whatever your future plans are and wherever you might hope to see yourself, it might be wise to make a decision sooner rather than later.
This way you can enjoy your holidays with peace of mind!