Tag Real Estate

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The Major Change in Mortgage Rules in 2018

The Major Change in Mortgage Rules in 2018

The purpose of this blog is to explain in a simple manner what the newly introduced stress test on uninsured mortgages mean. The many aspects of a mortgage are not addressed in this blog and the reader is advised to contact me directly or other mortgage professionals in the industry to inquire about the specifics of their situation and needs. Feel free to send your questions via the comments section of this blog.


Background:
OSFI (the Office of the Superintendent of Financial Institutions) published the final version of guideline B-20 (Residential Mortgage Underwriting Practices and Procedures) last October which comes into effect on January 1st, 2018 and applies to ALL federally regulated financial institutions. OSFI regulates 382 institutions between Banks, Trust Companies, Loan Companies, Life Insurance Companies, Federal Benefit Societies and Property and Casualty Insurance Companies.

The most talked about change in the mortgage industry to be implemented in 2018 is setting a new minimum qualifying rate or what is referred to as “stress test” for uninsured mortgages.

Insured vs. Uninsured Mortgages:
At the moment, a buyer who is paying 20% or more to purchase a residential property will not be subject to a “Stress test”, except in specific circumstances, or required to buy mortgage insurance. Such a loan is uninsured.

A buyer who is paying less than 20% to purchase a residential property has to undergo a stress test AND buy mortgage insurance. Therefore, the loan becomes insured

Effective Jan 2018, everyone applying for a mortgage through one of the federally regulated institutions will undergo a stress test. The most affected category are those paying 20% or more in down-payment AND applying for a fixed rate, 5-years term or more mortgage. This category of buyers/borrowers does not have to undergo a stress test as of today.


Lets look at some numbers in an example (the numbers below are estimates and are for indication purposes only – the reader is advised to consult with mortgage professionals for a proper calculation as it relates to the reader situation):

Scenario (1)
12

This example demonstrates that the family profile above might be able to get approved for a loan of $1,200,000 today but will only be able to secure $875,000 after Jan 2018 noting the assumptions above. It is important to remember that if the family was never interested in a $1,500,000 property and was only looking for a $1,000,000 – $1,200,000 property then nothing really will affect them.

Assumptions:
– The offered Mortgage from the lender is at a rate of 3.25% and 30 years amortisation.
– The stress test is based on 5.25% and 25 years amortisation.


Scenario (2)
12

This example demonstrates that the family profile above might be able to get approved for a loan of $720,000 today but will only be able to secure $520,000 after Jan 2018 noting the assumptions above. It is important to remember that if the family was never interested in a $900,000 property and was only looking for a $650,000 – $700,000 property then nothing really will affect them.

Assumptions:
– The offered Mortgage from the lender is at a rate of 3.25% and 30 years amortisation.
– The stress test is based on 5.25% and 25 years amortisation.


What is the logic behind the “stress test”?
Simply put, to test if the borrower is able to pay the mortgage if the lending rates increase by ensuring that the debt is still within reasonable range or ratio to the borrower’s gross income with the applied high rate.

Why do some argue that it does not make sense to apply it to uninsured mortgages?
At the moment, the stress test is required in certain situations, the most common two are:

  1. When a buyer/borrower is applying for a variable rate mortgage. In this situation, it is understandable why a stress test is required since the buyer/borrower is exposed directly and immediately to any changes in rates in the marketplace and hence the lender needs some sort of assurance that the buyer/borrower is able to fulfil his/her mortgage obligations if this happens.
  2. When a buyer/borrower is paying less than 20% down payment. In this situation, it is somewhat understandable why a stress test is required. Remember that this type of mortgage is insured. So the lender and the insurer are exposed to the possibility of the buyer/borrower defaulting and the lender not being able to recover the loan amount from selling the property (especially that the loan amount compared to the property value is high – High LTV or Loan-to-Value) . The stress test should give an indication to both the lender and insurer that although the buyer/borrower is not able to or chose not to pay 20% or more as down payment, the borrower is able to comfortably fulfil his/her mortgage obligations.

There are other situations where the stress test is also required but the above are the most common ones.

Contrary to the above, the most common situation where a stress test is not required is when a buyer/borrower applies for a Fixed Rate, 5-years or more term mortgage. Some argue that such a buyer/borrower SHOULD NOT be subject to a stress test. Such a contract is under a fixed rate for a lengthy period of time (5-years or more) so the payment will not change during this time. Subjecting this profile of buyer/borrower to the stress test might hinder some from buying the property that they want because of an unnecessary inflated rate “stress test” that the buyer/borrower will never experience during the term of the mortgage.

So if we are to conclude who the new regulation will affect the most, it is that category of buyer/borrowers. Those who saved enough to buy the house of their dreams and are pursuing a fixed rate mortgage for 5 years or more. Unfortunately, they now have to qualify at a rate 2% higher than what the lender is offering them.

It is important to note that purchase agreements signed prior to 2018 may not be subject to the new rules

Newcomers, foreign buyers, rental properties, private lending and other types of property purchases and mortgages will need to be addressed separately and will depend on each situation.

As mentioned earlier, there are many details associated with mortgage approvals and offerings. I hope that the above was simple and straight forward enough to give the reader a basic idea on what to expect starting Jan 2018.

Blogged by:
Mohammad Abusaa (M. Abusaa)
Real Estate Broker of Record & Mortgage Agent

m.abusaa@akarat.ca
D. 416 825 7775

An example of the effect of the Non-Resident Speculation Tax (NRST) on Foreign Students in The GTHA

Part of what we do at AKARAT is what we refer to as “Real Estate Planning” with our clients. We typically start with a meeting to understand our clients’ needs and capabilities and explain the different options within the real estate market that might fit their current situation and future goals. Depending on the complexity of the situation, we would also bring to the table professionals in the mortgage, financial planning, accounting and legal areas to complement our work.

One segment of clients that we deal with and advise are foreign buyers. Some of them have children attending university in the Greater Toronto & Hamilton Area (GTHA). The typical advice for a family that is planning to send their child/children to study in the GTHA is to purchase a house/Condo rather than spending 4+ years paying for rent or the dorms. This makes more sense of course to those with more than one child going to university within a 10 years period for example. The numbers, pre the recent announcement, for a typical one bedroom in downtown Toronto would be in the range below:

  • One bedroom condo in downtown Toronto rents for $1,700.
  • The same one bedroom unit sells for $450,000
  • A foreign buyer with solid income/employment, etc. should be able to secure a mortgage at 35% down payment
  • Total purchase cost will be around $170,000 (35% of property price plus purchase costs).
  • Monthly expenses $1,650
  • Assuming 4% annual appreciation in property price, and selling it after four years (completion of studies), the savings vs. rent will be around $57,000

So if the student/parents can afford a $170k down payment, such an option might be attractive to them.

TODAY, after the announcement and the implementation of the 15% Non-Resident Speculation Tax (NRST), the numbers still make sense BUT the capital requirement became higher. For the same example above, the purchaser will also need to pay 15% of the purchase price upfront which will be refunded from the government in two years plus interest. Therefore, the total purchase “initial cost” will be $227,500 ($160,000 + 15% of $450,000).

All in all, in the past, one of the challenges we had with foreign non-cash buyers was to secure a mortgage at the lowest down payment possible which typically ends up being 35% with some exceptions. Today, not only do we have to deal with the mortgage challenge, but also with the “extra” 15% required at the point of purchase. Some foreign buyers cannot afford it even cash buyers, others don’t want to take the risk (for example they might not qualify for the refund if their child decides to leave school after one year), and some simply don’t feel that they will ever get the refund!

I guess it is simply a different marketplace today which we will adapt to. The numbers are still attractive for this segment. If we revisit the example above, one can look at it as putting down 50% of the property price as initial investment, securing a 65% loan on the property and getting a refund of 15% of the value plus interest in two year. The proposition still stands strong, the numbers just changed.

Blogged by:
Mohammad Abusaa (M. Abusaa)
Real Estate Broker of Record & Mortgage Agent

m.abusaa@akarat.ca
D. 416 825 7775