4 Tips: How to Prep Mortgage Borrowers for New Stress Test Requirements

By: Penelope Graham, Zoocasa.

It hasn’t been an easy year to be a borrower, and conditions are poised to become even tougher: As home prices and interest rates rise, Canada’s lender regulator is considering new rules to further limit mortgage qualification.

While an official date is pending, it’s widely expected that the Office of the Superintendent of Financial Institutions will mandate a stress test for low-ratio borrowers as soon as October. The anticipated changes will pad a 2-percent qualifying threshold onto contract rates for those paying 20 percent or more on their home down payment. A ban on co-lending arrangements and new loan-to-value ratio requirements are also rumoured to be in the works.

Such changes are the latest in OSFI’s mandate to reduce lenders’ exposure to mortgages, and to discourage risky borrowing behaviour. A slew of lender changes, such as stricter underwriting requirements and portfolio insurance limitations, have already been absorbed by financial institutions. High-ratio borrowers have been stress tested since late 2016.

The Impact on the Housing Market

The B-21 requirements, however, target consumers at a time when monetary policy is tightening, and home buying conditions remain unfavourable. OSFI’s proposal, which was released for public review in July, has drawn concerns from all corners of the housing industry, as developers, mortgage brokers, and realtor associations say it’s too much, too soon.

In fact, it’ll be an outright assault on affordability, as stated by Ontario Real Estate Association President Tim Hudak. “With the latest plans of OSFI to make it harder to get a mortgage, Ontario realtors are getting increasingly concerned about what seems to be a war on first-time home buyers,” he said.

The consequences will be far-reaching, analysts agree; Mortgage Professionals Canada forecasts they’ll take a 10-15-percent bite out of annual sales, while the Canadian Home Builders Association believes it will impact the start of 20,000 – 30,0000 new units.

Limiting Buyer Affordability

The greatest impact, however, will arguably be felt in borrowers’ wallets. “If the proposal to add an additional 2 percent does is confirmed, your rate would go from 3.24 to 5.24 percent. That means requiring a $129,000 (a 16-percent increase),” says Mike Bricknell, a mortgage broker at CanWise Financial.
“Most buyers, and especially first-timers, will not have an extra $20,000 in income, nor will they be able to pull together an even higher down payment on short notice.”

“Most buyers, and especially first-timers, will not have an extra $20,000 in income, nor will they be able to pull together an even higher down payment on short notice.”

Fewer Alternative Lending Options

He argues this, along with the banning of co-lending agreements, will only push more borrowers into the private financing market or prompt them to seek out shorter fixed or variable terms, which will increase their overall exposure to market volatility.

“Borrowers who are impacted often have unforeseen personal matters, for example, an elderly parent who needs help, marital splits, an ill loved one, kids going off to school, or other situations that would require this type of loan. For those who don’t fit within the “Big Bank” criteria, it can be very difficult to obtain this kind of financing, and so bundled loans have been a great asset,” he says.

“Restricting this type of loan will reduce these borrowers’ options, sending them instead to the dark ‘private’ loan market, where super-high rates and fees are the norms. In these situations, repayments tend to be interest-only, and can make it even more difficult for those in challenging financial situations to dig themselves back out.”

How Borrowers Can Prepare for B-21 Changes

The saying may be that hindsight is 20/20, but the silver lining is that mortgage professionals have the opportunity to prepare clients for these upcoming changes. Here are a few ways savvy clients can protect affordability and avoid interest rate sticker shock:

Adjust buying expectations: Perhaps the harshest reality of B-21 is that buyers will see their overall spending power shrink. Having to pony up additional tens of thousands of dollars can be the difference between a two-and-one bedroom, a parking spot, or desirable location. It could also be the difference between purchasing a detached home or Toronto townhouse, or switching focus from the pricey 416 to the Hamilton real estate market instead. “Essentially, everybody is going to step down a rung or two, which means there will be real pressure on all home prices to also fall by a rung or two,” said MPC President Paul Taylor in an interview with the Globe and Mail.

Proactively pad in 2 percent: While there are a number of competitive contract rates available, remind clients to build in the proposed stress test requirement when calculating affordability, and to adjust their budget or down payment accordingly. Use a mortgage calculator to help determine maximum affordability, and assess whether payments are still within budget should the rate be significantly higher.

Take advantage of pre-payment options: Clients coming up for renewal are wise to utilize any lump-sum or accelerated payment features included in their current term to reduce the amount they’ll need to qualify for says Bricknell. “If your finances can handle it, it’s a great idea to exercise your mortgage pre-payment options before your current term renews as it will put you in a better position for qualifying under the proposed rule changes.”

Shop around and compare: Working with a qualified broker with access to a wide variety of rates is especially valuable in a tight borrowing environment; scoring a competitive rate from the offset will mitigate the impact of stress testing, save in interest paid over the term.

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