January 2018 will mark a substantial shift in Canada’s real estate market. The change is based on the recommendations of the Office of the Superintendent of Financial Institutions, an agency tasked with the regulation of Canadian financial security as a whole. With only a few dips in the seemingly constant upward trend in home prices, and Canada’s continued economic growth, the Bank of Canada is taking the OSFI’s report to heart.
Increasing interest rates is, of course, a primary measure taken to stabilize growth and in turn mitigate inflation. With Canada’s economy in a strong stance and the outlook positive, the government is now aiming to head off excessive growth that has the potential to create the type of bubble that has devastated other economies, not to mention families around the world.
So, what does this mean for homebuyers? Well, that’s a little more complicated.
First, financing qualifications generally state that not more than 40% of gross household income should be consumed by debt. Additionally, not more than 32% should go to housing costs. On top of this, the absolute minimum down payment must be 5% for a home under $500,000, and if the buyer has fewer than 20% they must have their mortgage insured by the Canada Mortgage and Housing Corporation. For a home over $500,000, an additional 10% down on the amount over $500,000 is required.
Previously, in most buying scenarios you were required only to qualify for your mortgage at the current interest rate unless you had an insured mortgage. As interest rates are projected to rise with near certainty, the concern becomes whether or not you can afford your home when they do. For this reason, the new rules will require that you still fall within the above guidelines in a worst-case scenario, regardless of your down payment amount; that scenario being an extreme increase in interest rates.
Moneylenders are in the business of risk management. They give you money in exchange for the promise that you’ll pay them back, plus a bit extra for their trouble. If they lend you money to buy a home and you aren’t able to pay it back, not only do they lose money but they can’t allow you to live in the home if you aren’t paying for it so they also have to go through an extensive process of taking it back and then getting the amount that they borrowed on your behalf back! Is it any wonder they want to avoid having hundreds of thousands of people suddenly become unable to repay their mortgage loans?
The solution is what’s called a stress test. Most people are familiar with a physical stress test, where a person is hooked up to machines and then physically exerts him or herself to measure various response times. Essentially, they are figuring out the maximum ability to complete the exercise before the body cannot continue and gives out. A mortgage stress test is the same, but for your bank account. When interest rates change, your payments will change. What is the maximum payment you can afford before your home becomes too expensive? Regardless of your down payment, you will now be required to qualify for your mortgage at an increased rate. You won’t need to pay that rate, only prove that you are able to so you and your lender can rest easy knowing that you’ll be able to keep your home as the economy changes.
So what’s the downside?
As a buyer, this means that you’ll have less overall buying power. The average buyer in Calgary will be able to afford approximately 20% less house. Having a current pre-approval may not protect you if you are still in the midst of your home search.
The below chart outlines how the changes will affect the budget of buyers across various benchmark prices, assuming a 20% down payment:
Current Qualification Amount: $350,000
January 2018 Qualification Amount: $290,000
Current Qualification Amount: $500,000
January 2018 Qualification Amount: $420,000
Current Qualification Amount: $750,000
January 2018 Qualification Amount: $620,000
Current Qualification Amount: $1,000,000
January 2018 Qualification Amount: $800,000
How do I prepare for this?
Your first step is to have an honest conversation with industry professionals. Buyers will want to reach out to your mortgage specialist to ensure your pre-approval amount is reflective of the criteria you’ll need to meet at the time you find a home and make an offer. This will likely also affect your home search parameters, so you’ll need to update your realtor in order to receive listings that align with those.
I’m selling my home, how does this affect me?
As a seller, your audience and market has changed. Depending on what range your home is in; you now may have a completely new set of buyers. This could increase your prospects or it could decrease the potential buyers who can afford your home. As demand for homes will certainly shift with the changing mortgage rules, you will need to think carefully about how your home is positioned in the market.
Sellers should expect to discuss this change with their realtors, as they will have a better idea of whether the market for that particular home is growing or shrinking. Based on this the demand for your home will change, which may need to be reflected in the price. You may also want to prepare for a lull in activity as buyers readjust to the circumstances and restart their home search. Many buyers may also wait to see if newly listed home prices change in relation to the new rules.
Long story short, you’ll still be able to buy or sell your home, though the process may look slightly different. Regardless of whether you are buying or selling, reaching out to trusted professionals ensures you receive the best information so that you can successfully plan to navigate the shifting real estate world.
Do you have questions? Please call us, we are always happy to provide education and information. (403)835-6338