Fixed-rate borrowers must qualify at posted rate

New rules come into effect today

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fixed-rate mortgage

Applying for a new mortgage won’t be so easy after today’s announcement by Federal Finance Minister Bill Morneau. That’s because anyone looking to buy a home will have to qualify for that new mortgage based on posted rates, not discounted rates.

As MoneySense reported in June, up until now, homebuyers could skirt the rules if they opted for a five-year fixed rate. Rather than qualifying for the higher, posted rate, these buyers could qualify for the loan based on the much lower discounted rates, explained Calum Ross, a Toronto-based independent mortgage broker, who works with high net worth clients as a dually licensed wealth advisor (with his MBA) and mortgage broker.

How this loophole helped homebuyers

Under current Canadian mortgage qualification rules, home buyers can only get a mortgage if their debt-ratios show that they can make payments based on the Bank of Canada’s qualifying rate. This mortgage qualifying rate (MQR) is based on the posted five-year fixed rate and in 2015, it hovered around 4.65%.

However, until the Federal Minister made his announcement today, anyone opting for a five-year fixed didn’t have to use the 4.65% rate, but rather the much lower contract rate. In 2015, this contract rate bounced between 1.99% and 2.99%.

Thing is, the contract rate is the equivalent of a discount rate—and, at present, about 200 basis points below the stress-test mortgage qualifying rate.

“This is a big problem,” explained Ross, earlier this year. “By qualifying a buyer at the higher, posted rate we protect the downside risk, the impact higher mortgage rates will have on a homeowner’s budget. In essence, these regulations stress-test whether or not a buyer can withstand a 1% to 2% increase in mortgage rates.”

Ross added: “Up until now, changes to mortgage regulations have focused on down payment minimums, but I fundamentally believe that where we really need intervention is in how we qualify borrowers,” says Ross. He believes the regulations need to be further amended so that all borrowers would qualify based on posted rates. “It’s irresponsible to simply ignore this.”

Apparently, Morneau was listening. In today’s announcement, the Federal Finance Minister stated that the reason for this current change to mortgage qualification rules is to “Bring consistency to mortgage insurance rules by standardizing eligibility criteria for high- and low-ratio insured mortgages, including a mortgage rate stress test.”

It is estimated that the implementation of this mortgage qualification rule will impact between 7% and 10% of home buyers.

What it means if you’re buying a home

Morneau’s change to mortgage qualification rules will be retroactive and apply to any new mortgage created on or after October 17, 2016.

That means if a homebuyer were to opt for a five-year mortgage, at 2.4%, they’d have to prove to the lender that they could make monthly mortgage payments based on the 4.65% MQR. On a $650,000 home, with 10% down, that would mean this homebuyer would need to show that they could increase their monthly mortgage payment by almost $700 per month, in order to qualify for that mortgage.

According to RateHub.ca’s mortgage affordability calculator, a family with an annual income of $100,000, with a down payment of $40,000 and using a five-year fixed mortgage rate of 2.17% will qualify to purchase a home worth $665,435. (Assumes property tax of $400 and monthly heating costs of $150.)

Under these new rules, this same family would have to qualify for a mortgage using the posted rate of 4.64%. This would drop their home purchase price to $505,762—a difference of $159,673, or a 24% reduction in the home purchase price.

 

The rationale for using the posted rate to qualify buyers is to “…protect Canadians by ensuring sufficient flexibility to support mortgage payments at higher interest rates in the future, for example, when the mortgage term is up for renewal. This requirement also protects taxpayers who support homeownership through government-backed insured mortgages,” explained the Department of Finance through email.

Read more: Documents needed to get the best mortgage rates »
Read more: How to get a mortgage (when you’re not the ideal borrower) »

What next?

Before the summer Morneau created a tri-level governmental task force that was given the job of coming up with recommendations on how to better position Canada’s real estate market, to avoid a price crash and still create affordable housing options for working Canadians.

The task force has yet to present their recommendations. Morneau had committed to releasing these recommendations by the end of the summer, however, a spokesperson for the Department of Finance confirmed that the task force “will continue to collaborate throughout the next few months.”

Based on this delay, recommended changes from this housing task force may not be announced or implemented until early 2017, or even after the next Federal Liberal Budget in the spring of 2017.
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9 comments on “Fixed-rate borrowers must qualify at posted rate

  1. Who has estimated 7-10%? Would love to check the source. Would be interesting to see what percentage of first – time buyers would be affected.

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  2. The banks will just lower the posted rate to what they actually lend money at rather than the artificial posted rate that nobody ever borrowers at, but that the banks use to penalize early payment of mortgages with.

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  3. I believe that a prudent lender and not one desperate for commission should be advising new home owners based on this guidline however I have serious concerns about the value of all property in Canada. This new policy will reduce the number of qualified buyers in every price range 100-200 200-300, 300-400 thousand. Economics 101 should tell us that with less demand from there being less qualified buyers under new rules that housing prices across Canada will drop. This could be drastic for many Canadians who have bought in the last few years if their homes are now worth substantially less. Time will tell but I’m concerned that this policy will incite the housing crash that it was designed to prevent.

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    • Good point,

      I will say the problem in Van City and Toronto is the influx of foreign cash and foreign buyers. Taxing them and charging them capital gains upon selling would probably be the best solution and distort the S-D dynamics the least from the Canadian resident perspective.

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  4. hi all thank you for the article. a couple of items. according to ratehub, with a $40,000 down payment (assuming other conditions are met) you could qualify for a $665,000 mortgage. This is not the standard 10% down that mortgage affordability projections assume. Also, on a $665K home they assume that property taxes would be $400. If this is annually it is far to little. If it is monthly it is too much. It is close for Saskatoon, but in North Vancouver would be $275. Every $100 per month drastically changes the highest dollar value of a home that they can qualify for.
    Great conversation!! Thank you.

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    • Great point Flavio!

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  5. The article’s headline is misleading since it suggests that there are no more discounts on mortgages… discounts are still available, it’s only the rate used to qualify that’s higher! Right?!

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  6. Click bait title, the client still gets the discounted, they just have to get approved at the higher rate.

    Reply

  7. You might want to reiterate that this only applies to insured mortgages so that readers like me who skim articles don’t misunderstand the new rules and get too concerned about the affect come renewal time.

    Reply

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