For starters, let’s recall that when this measure was rolled out in October 2016 by Canada’s Minister of Finance, Bill Morneau, its primary purpose was to counter the abusive practices of certain foreign investors engaged in real estate speculation in Canada, and thus to control skyrocketing real estate prices in certain markets. The other goal of the new rules is to avoid a situation where future owners might be unable to make their mortgage payments if interest rates start to climb.
Under what circumstances do the new rules apply?
The new rules apply to all insured loans, regardless of the term (1, 2, 5 years or more), and regardless of whether the interest rate is fixed or variable.
Will you need to make a bigger down payment?
No, it’s still possible to buy a home with a down payment of 5%. When the down payment is less than 20%, however, the loan must be insured and the new rules apply.
What’s an insured loan?
If your down payment represents less than 20% of the value of your purchase, your loan request must be accompanied by a request for mortgage insurance. Most buyers turn to the CMHC (Canada Mortgage and Housing Corporation) for mortgage loan insurance, but it is also offered by private companies.
Why do you need this insurance, and how much does it cost?
The cost is based on the down payment, and varies between 0.5% and 2.9% of the amount of the mortgage. This mandatory insurance is beneficial for the buyers’ market, helping to lower mortgage rates by reducing the risk of default.
How do the new rules work?
It’s fairly simple: this measure involves a simulation aimed at evaluating your ability to pay your mortgage if the current rates were to rise to the level of the mortgage rates offered by the largest banks over the past five years. According to the Bank of Canada, this average rate is currently 4.64%.
Therefore, even if the actual rate you get from your bank is 2.35%, your financial institution will use the average rate proposed by the Bank of Canada (4.64%) to calculate your ability to pay.
Bear in mind that this calculation is used only to confirm your financial ability to deal with a rise in interest rates, and that your actual payment will be based on the negotiated rate. For your loan qualification, the bank will determine a fictitious mortgage payment based on this higher rate, and then add expenses such as municipal and school taxes, annual heating costs, and 50% of annual condo fees (if applicable) plus your existing debts. The resulting total will determine your debt ratio, and must not exceed 35 to 40% of your gross income (up to 44% for those with excellent credit).
So in order to verify your ability to pay back the loan, the bank will assume a fictitious monthly mortgage payment of $1,551.83, but your actual payment will be $1,217.98.
These new rules will certainly have an impact on buyers’ borrowing capacity, and may therefore affect the value of the property they will be able to afford. However, they should not be seen as an obstacle to a home purchase, but rather as providing additional peace of mind with regard to your ability to deal with a possible rise in interest rates.