Update to Canada’s Mortgage Qualifying Rules Explained

Wednesday Aug 25th, 2021

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Earlier this summer, new changes were announced for the federal mortgage stress test, shifting the ground again in terms of how much house new and seasoned home buyers are qualified to purchase. 

In April, Canada’s financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), proposed an increase for the stress test’s minimum qualifying rate on uninsured mortgages. This raised the previous rate from 4.79% to its current value of 5.25%.

As of June 1, 2021, the new qualifying rate for the stress test is applicable to all federally regulated mortgages, including both uninsured and insured mortgages. Insured mortgages apply to borrowers who have a downpayment that’s less than 20% of their home purchase, while uninsured mortgages are available to borrowers who have a downpayment worth 20% or more.

The stress test’s minimum qualifying rate helps ensure borrowers can still make mortgage payments in the event of a change in circumstances, such as a job loss or a rise in interest rates. In its rate increase announcements, OSFI stated Canada’s current housing market, which has seen record-high sales, bidding wars, and soaring prices since mid-2020, puts lenders at risk. The latest rate change helps to “support financial resilience should economic circumstances change,” according to OSFI.

“In a complicated and sometimes volatile housing market, the need for sound mortgage underwriting cannot be underestimated,” said Ben Gully, Assistant Superintendent of OSFI, in a statement regarding the qualifying rate change announcement. 

If you’re in the market to buy a home, then you’ll probably want to know how the latest changes to the mortgage qualification rules will affect you. James Laird, co-founder of Ratehub.ca and President of CanWise Financial mortgage brokerage, gives us some insight on what the most recent set of amendments mean.

What is the stress test, and why did it change?

Canada’s red-hot housing market was already showing signs of cooling down after it reached all-time record levels in March 2021, according to the Canadian Real Estate Association (CREA). In its most recent report, CREA noted the housing market has continued to show signs of moderation, with sales dropping by 7.4% month-over month in May.

However, despite this gradual tapering off, Laird said it became apparent in the first quarter of 2021 that OSFI was going to make a change.

“I think it was quite obvious they were going to do something and I think this is a fairly measured response. The market had already kind of cooled a little bit,” said Laird. “Now it’s in effect for the next time things really heat up.”

Image via Sidekix Media

Originally implemented in 2018, the mortgage stress test is designed to prove you can still make your regular mortgage payments even if interest rates were to rise in the future. When you apply for a mortgage, you are offered a contracted rate, which lenders must check against the stress test’s higher qualifying rate—currently 5.25%, or the contracted rate plus two percent, whichever is higher—to ensure you can make payments. The stress test is applicable to new home buyers, in addition to existing mortgage holders who want to refinance or switch lenders. 

Who does this change affect and by how much?

In terms of how much the latest stress test change has impacted purchasing power, Laird said the new qualifying rate reduces maximum affordability by about 5%. If you’re trying to buy a home or refinance your existing mortgage, this means you now qualify for 5% less than what you would have when the rate was set at 4.79% prior to June 1st, 2021. 

Whenever there is any kind of financial tightening, first-time buyers will be affected the most, said Laird. This is especially true in high-priced markets like Toronto or Vancouver where the barrier to entry tends to be higher. For new buyers who were hoping to purchase near the maximum of their borrowing capacity, they may no longer qualify for the property they wanted to buy prior to the new changes.

Image via James Bombales

“If you had a little bit of wiggle room for what you wanted to do, this 5% reduction [is] probably not going to affect you,” explained Laird. “The people who thought ‘Okay, I just barely qualify for what I want,’ and now [say] ‘Okay, I just barely do NOT qualify for what I want,’ it’s those people who have to do something.”

Buyers who now no longer qualify for the home they desire have a few options, Laird said. This includes adjusting the type of home they want to purchase, or postponing their property purchase until they can save more money or boost their household income.

In comparison to first-time buyers, existing homeowners will likely have built-up home equity, along with potentially higher incomes and better credit scores working in their favour, said Laird.

Will this have an effect on the overall housing market?

In addition to amending the stress test’s minimum qualifying rate, OSFI has now implemented a process to review the rate annually in December ahead of the busy spring market. Laird said elements like the country’s economy, interest rates, and home prices will factor into their decision to make any future changes to the rate. 

Laird also explained the intent of tightening policies is to keep real estate prices in check and to slow price appreciation, which can be a help to first-time buyers. However, with so many other market factors at play, it can be difficult to pinpoint the timeline of this desired outcome, or the precise effect on home prices.

Image via Sidekix Media

“You really can’t tell the effects because it’s mixed in with so many variables, but if you believe this will have its desired effect, then it should mean real estate is a little bit less valuable than it would have been had this policy not been put into place,” said Laird. 

While the stress test plays a role in the outcome of the housing market, it’s only one factor—pent-up demand from households who wanted to change the type of real estate they owned during the pandemic have also had an impact, for example. Laird also points to the return of immigration to Canada, which will bring more buyer demand to the housing market.

“Going forward, yes, the stress test matters, but probably what matters more [is] whenever immigration opens up again and there are new Canadians coming [and] adding demand. That’s extremely significant.” said Laird.

“If and when rates move up, and by how much, that’s more significant than this [change]. This is not nothing, but it’s not the biggest factor that causes a hot or cold market,” he added.

Image via James Bombales

If you’re looking for advice on the latest changes to the stress test, or want to understand more about the current market, recruit the help of a REALTOR® for the most up-to-date information. 

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