An effort to reduce average Canadian debt with the new mortgage stress test
House hunting? You may have heard of the new mortgage rules from the Office of the Superintendent of Financial Institutions Canada (OFSI) that came into effect on January 1, 2018. In a nutshell, high ratio borrowers (who have less than 20 per cent down) nowneed to qualify for their mortgage payments at an interest rate at least two points higher than the contractual rate, or the five-year posted rate, whichever is higher.
Why is this happening?
Some markets in Canada, most notably Toronto and Vancouver have been dangerously hot over the last few years. The combination of escalating property prices and low interest rates have created extremely high household debt, largely because homebuyers are routinely maxing out their mortgages just to get into the market. Average Canadian debt is so high at the moment that the Government of Canada is concerned about potential fall out from rising interest rates, hence the mortgage stress test.
“What’s been happening commonly in these markets is that lenders were qualifying people at lower rates in order to get the mortgage that they wanted. These new regulations will help homebuyers get a more realistic snapshot of their house hunting budget in the context of their income and other debts,” says Jeff Schwartz Executive Director, Consolidated Credit Counseling Services of Canada.
Taking on big mortgages is dangerous for a couple of reasons: high mortgage payments mean that people are shouldering debt loads that make them vulnerable, especially if interest rates go up. Secondly, if property values drop, there’s a chance that people will owe more than they own. Real estate values move in cycles; they go up, but they also go down.
Do your own stress test
The government is concerned about the vulnerabilities that these high debts bring about, and you should be too. You should always give yourself your own stress test before you think about buying a home and taking on too much mortgage.
Look at what your mortgage payments might be for the home you want. How much of your income is left over to cover other expenses? Are you going to be living paycheque to paycheque, or do you have the ability to continue to save and keep credit use to a minimum.
“Maxing out your mortgage to buy a home today is short-term thinking. You may very well have to turn to debt to cover costs in the future, which will create a whole other set of problems,” says Schwartz.
Press the pause button
There’s a general sense that people may rush out to qualify for mortgages before these new rules take effect. However, you need to ask yourself a question; if you can’t afford the home you want under the new mortgage rules, can you really afford it at all?
The criteria that lenders use to decide if you can afford a home are based on your income vs. your debt and how much of that income is going to service debt. Of course, higher rates mean higher payements. If you’re stretched so thin that an increase in interest rates means that you can’t afford your payments, do yourself a financial favour; walk away and retool your househunt so it fits in your budget.
That may mean buying a smaller home, changing neighbourhoods or maybe even deferring your home purchase until you’ve got more money saved in order to reduce the debt that you need to take out.
Buying a home is about acheiving the goal of homeownership and for some, having status as a homeowner, but it really should be a part of a long term plan that fits into your budget.