Mortgage rules: What do the changes mean?

A major shift in mortgage rules announced by the federal government this week will drive up rates for consumers and cut competition in the lending sector, say some in the industry.

Mortgage expert Robert McLister says Ottawa is cracking the housing market with a “sledgehammer.”

He predicts consumers will bear the brunt of the blow and that housing prices will tumble because a “sizable minority” of first-time and high-ratio buyers will no longer qualify for the mortgage amount they want.

The federal government says it’s responding to concerns that sharp increases in housing prices in Toronto, Vancouver and elsewhere could increase defaults in the future, should historically low interest rates finally start to climb.

One of the key changes means that all homebuyers seeking an insured mortgage, regardless of how much they have for a down payment, will be subject to a mortgage rate stress test beginning Oct. 17. Before now, those with less than a 20 per cent down payment were required to pass a stress test and have mortgage insurance backed by the federal government through the Canada Mortgage and Housing Corporation.

But those putting down more than 20 per cent who were seeking an insured mortgage through a private insurer were not subjected to the stress test.

The test measures whether the buyer could still afford to make payments if mortgage rates rose to the Bank of Canada’s posted five-year fixed mortgage rate.

That rate is usually significantly higher than what a buyer can negotiate with banks or other lenders. For instance, TD has a five-year fixed rate mortgage at 2.59 per cent, while the Bank of Canada’s rate is 4.64 per cent.

The stress test also sets a ceiling of no more than 39 per cent of household income being necessary to cover home-carrying costs such as mortgage payments, heat and taxes.

Until now, buyers with more than a 20 per cent down payment opting for mortgage insurance have escaped such scrutiny. They were able to obtain low-ratio insurance sold through two private insurers, but backed by the federal government, subject to a 10 per cent deductible. Starting Nov.30, new criteria for low-ratio insurance will take effect. To qualify, the mortgage’s amortization period must be 25 years or less, the purchase price be less than $1 million, the property be owner-occupied, and the buyer have a credit score of 600 or more.

“I don’t think this has been thought through at all,” McLister, who writes for Canadian Mortgage Trends, told CTVNews.ca. He says the effect is that refinances, jumbo mortgages and rental business will have to be handed over by brokers and non-bank lenders to the banks, says McLister. That will hurt competition and drive up mortgage rates and fees.

“There was no industry consultation. Every lender I spoke to said they had no inkling this was coming. This is a big fat mistake.”

In fact, McLister says the changes are a “solution to a problem that doesn’t exist” because only one in 357 Canadian homeowners defaults on a mortgage.

“Regulators are under intense pressure to do something because home prices are climbing fast and may be over-valued in some markets. They want to avoid any kind of catastrophe on their watch,” he said.

“But the knee-jerk reaction will be so damaging, they could cause the sell-off they are trying to avoid.”

He says mortgage insurance provider Genworth Canada estimates the new rules mean up to one-third of its first-time homebuyers will not qualify for a mortgage.

Suzanne Boyce, owner of The Personal Mortgage Group in Hamilton, says she fears the changes will ultimately limit options available to the public. Canada already has some of the stiffest standards for qualifying for mortgages in the world, she says.

Boyce says young people trying for the first time to get into a booming housing market and those who qualify for the low posted rates might not qualify for the higher rates right away.

“Those borderline people trying to break in before they get out-priced permanently may be kept out. It makes me wonder if we’re heading for a European-type market where home ownership is not as common.”

The new rules also mean that, beginning this tax year, all home sales must be reported to the Canada Revenue Agency. The gains from sales of primary residences will remain tax-free, but the government is aiming to block foreign buyers from purchasing and flipping homes while falsely claiming the primary residence exemption from capital gains tax.

Finally, the government says it will shift some of the risk of defaults against insured mortgages to banks and other lenders. Ottawa says its shouldering 100 per cent of the cost of a defaulted mortgage is “unique” in the world. How the government plans to share some of that risk with lenders remains to be seen.