In late 2016, Canada’s new mortgage rules – aimed at promoting responsible homeownership – were introduced by the federal government. Although the changes included measures geared toward curbing foreign real estate speculation and others specific to low loan-to-value mortgages, let’s focus on the change most likely to affect affordability for you, a first-time homebuyer purchasing with less than 20% down: the interest rate stress test.
The affordability of Homeownership has been helped in recent years by low interest rates and the availability of high loan-to-value mortgages backed by mortgage insurance. But what would happen if those interest rates were to jump? Concerned by that scenario, the government introduced tougher interest rate stress-test criteria in fall 2016, with the aim at preparing perspective homebuyers for a future rise in interest rates. What does that mean for you? More likely than not, less money to work with. Here’s why.
Implications of the stress test
Lenders and mortgage insurers look at two debt service ratios when qualifying you for a mortgage and mortgage insurance.
- Gross debt service (GDS)
The carrying costs of your home, such as mortgage payments, taxes, heating, etc., relative to your income.
- Total debt service (TDS)
Your home carrying costs (mortgage payments, taxes, heating, etc.) plus your debt payments (credit cards, student loans, car loans, etc.), again relative to your income.
To qualify for mortgage insurance, the highest allowable GDS ratio is 39% and the highest allowable TDS ratio is 44%.
While you may qualify for a fantastic five-year fixed mortgage rate from your bank (2.94%, for example), the new rules use the Bank of Canada’s five-year fixed mortgage rate (4.64% in late 2016, for example) to determine whether you can afford your mortgage payments.
This tougher affordability standard acts as a buffer to test whether or not you could still afford your mortgage if interest rates were to rise dramatically.
RESULT: The new rules mean you can afford less house for your income – approximately a 20% to 30% reduction in the mortgage amount you qualify for.
What can you do?
Canada’s new mortgage rules, while the subject of much debate, are here to stay. But the good news is, working within them is possible! You may have to revise your plans or timelines, but first-time homebuyers can still get into the real estate market.
Get yourself on track to buy your first home by laying the groundwork for responsible homeownership: reduce your consumer debt, save for a larger down payment, and boost your overall financial fitness.