Canada's Controversial New Mortgage Rules

Written by Posted On Monday, 27 November 2017 10:57

Canada's banking regulators think that home buyers are spending too much money and taking on too much debt. Starting on Jan. 1, 2018, it will be tougher for anyone taking out a new mortgage from a federally regulated lender to qualify for a mortgage. That includes people who want to renew a mortgage from a different lender than their current provider.

To qualify, borrowers must be able to pass a "stress test" and prove that they could afford to pay the current mortgage rate plus two percentage points. The rule applies to federally regulated lenders, which includes the major banks. Those who are renewing an existing mortgage are exempt from the stress-test provision if they don't switch lenders, but if they want to shop around for a new rate they'll have to pass the test for the new provider.

Another option is to go to lenders that are not governed by the federal regulator, such as credit unions and private lenders.

"The Office of the Superintendent of Financial Institutions (OSFI) is keenly aware of the potential risks caused by high household indebtedness across Canada and by high real estate prices in some markets," said superintendent Jeremy Rudin in a speech to the Economic Club of Canada.

"We are not waiting to see those risks crystalize in rising arrears and defaults before we act. Rather, we are adapting our standards to new developments."

Benjamin Tal of CIBC Capital Markets says the change "reduces the purchasing power of typical buyers by close to 20 per cent, and we estimate that no less than 10 to 15 per cent of mortgage originations will be impacted."

Scotiabank's Adrienne Warren also estimates that 10 per cent "of current loan applications would no longer qualify under the new rules. The overall impact on sales, however, is likely to be smaller, as some potential buyers could choose to purchase a lower-priced home, while others may be able to extend their amortization period or opt for a lower variable mortgage rate in order to extend their buying power."

The OSFI decisions have come under heavy criticism from the real estate and mortgage industries, as well as other economists.

Jim MacGee, a fellow at the C.D. Howe Institute, wrote in a memo to Finance Minister Bill Morneau that the new rules unduly limit competition among lenders. "In response to concerns that simply adding two percentage points to the quoted mortgage rate would encourage borrowers to shift from five-year fixed mortgages to shorter-term mortgages with variable rates, OSFI requires lenders to use the higher of the rate offered by the lender plus two per cent or the average five-year fixed rate posted by the six largest banks. This lowers the incentives for a lender to offer a low interest rate to help a borrower qualify for a mortgage."

He says that "borrowers with high debt-to-income ratios may find that they can only qualify for a renewal with their existing lender. This removes the option to shop for a better rate and limits borrowers' bargaining power on renewal. This is likely to result in higher rates for borrowers who already face high debt payments relative to their income."

As many as one in six people renewing their mortgage "could be trapped at their existing bank because they can't pass the stress test at another lender. And if a bank knows you can't leave, you can bet your boots they'll use that as leverage to serve up subpar renewal rates," wrote founder Robert McLister in a column for the Globe & Mail.

The Fraser Institute points out that the rate of residential mortgage arrears in Canada, where the borrower is more than 90 days behind in payments, is "virtually unchanged from 2002 and hasn't exceeded 0.45 per cent, even during the 2009 financial crisis, when the U.S. rate of arrears neared five per cent."

Neil Mohindra, public policy consultant at the Fraser Institute, says the "stress test for financially sound home buyers is unnecessary and will do more harm than good -- Canadian home buyers will pay the price."

His study on the regulations concludes that homebuyers may need to settle for less desirable homes than the ones they prefer, and that they "may seek out less-regulated mortgage finance companies, which are funded by private investors and charge higher interest rates."

It may also prompt people to choose shorter-term variable loans, which are more vulnerable to rate fluctuations than longer-term fixed-rate mortgages.

"It is one thing to act before a problem emerges and another to search for a problem where it does not exist," write Sean Spear and Jane Londerville in a paper for the Macdonald-Laurier Institute. "This is regulation-making in search of a problem."

They say the policy "also conflicts with the intent of other policies, such as the current government's pledge to significantly increase the Home Buyer's Plan and make it more flexible for first-time buyers." (The plan allows buyers to borrow funds from their Registered Retirement Savings Plan.)

"This is the type of policy incoherence that we see across federal housing policy," write Spear and Londerville.

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Jim Adair

Jim Adair has been writing about Canadian real estate, home building and renovation issues for more than 40 years. He is the former editor of Canada’s leading trade magazine for real estate professionals, as well as several home building, décor and renovation titles. You can contact him at [email protected]

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