Since January 2018, Canadians have had a much harder time buying a house, thanks to the new mortgage rules introduced by the federal government. Whether buying your first home or refinancing a current mortgage, these mortgage rules from 2018 affect you. Read on to learn about the mortgage stress test and how it impacts homebuyers in Canada.
What is the Mortgage Stress Test?
With skyrocketing housing prices and low mortgage interest rates, the Canadian federal government made new mortgage rules in 2018 to cool the real estate market. As of January 1, 2018, Canadians must pass a “stress test” to qualify for a mortgage loan – no matter how big their down payment is.
What is the stress test? It’s a financial challenge: borrowers must prove that they can afford to carry a mortgage at a higher interest rate than what may be offered by a financial institution. When applying for financing, you will need to qualify for:
- The five-year benchmark rate that’s published by the Bank of Canada; OR
- A contractual rate offered on your mortgage lender plus 2%
Ultimately, you must qualify for whichever amount is higher to get approved for a mortgage. What’s the point of the stress test? It’s to stop Canadians from taking on more debt than they can handle and show that they can carry a mortgage even under financial duress. Ultimately, these new mortgage rule changes have made it increasingly difficult for some Canadians to qualify for a mortgage.
What Does it Mean for Home Buyers?
These new mortgage rules mean that your purchasing power could be reduced by as much as 20%. When applying for a mortgage today, the amount that you qualify for doesn’t depend on the rate that the lender is offering. For example, if they are offering a 4% interest rate, you will have to qualify for your mortgage at the 5-year Bank of Canada benchmark rate or 6% (4% + 2%) – whichever number is higher. As a result, the amount that you can borrow could be significantly smaller.
It’s also likely that millennial buyers, who have statistically lower salaries than other demographics, won’t be able to borrow as much as before. Plus, since they’re less likely to bring home equity into a new home purchase, they often have less purchasing power.
What Can First-Time Home Buyers Do?
Don’t panic: if you’re a first-time home buyer, you’re not out of the real estate market altogether. The best way to combat these new mortgage rules is to save a hefty first time home buyer down payment. A “down payment” is the amount of money that you put towards the purchase of a home. In general, the larger your down payment, the easier it is to obtain a mortgage. This is because the more cash you can put down from your savings, the less money needed to borrow to cover the home price.
First-time homebuyers can borrow up to $35,000, tax-free, from a Registered Retirement Savings Plan (RRSP) under the Home Buyers Plan. If you’re purchasing the home with a spouse or partner, each of you can access the HBP for a total of $70,000. You must pay back the money into your respective RRSPs over a 15-year period, or you will have to pay income tax on those funds.
A good way to get started is to set up an automatic savings program that funnels regular monetary contributions into a Tax Free-Savings Account (TFSA) or high-interest savings account. In case you haven’t heard, a TFSA is an account type that allows Canadians to save or invest and not pay tax on money they make or withdraw. Likewise, contributing regularly to a high-interest savings account will help you sock away cash quickly but also earn high interest on your dough. Either option is effective because your money is easily cashed out if it’s needed to buy a home.
If you don’t have an RRSP or other savings, a good way to get started is to set up an automatic savings program that funnels regular monetary contributions into a Tax Free-Savings Account (TFSA) or high-interest savings account. In case you haven’t heard, a TFSA is an account type that allows Canadians to save or invest and not pay tax on money they make or withdraw. With an annual contribution limit of $6,000 in 2021, this is a great place to stow your moolah. Likewise, contributing regularly to a high-interest savings account will help you sock away cash quickly but also earn high interest on your dough. Either option is effective because your money is easily cashed out when it’s needed to buy a home.
What Happens If You’re Refinancing?
If you refinance your mortgage loan, you’ll have to undergo the stress test – and that might mean not qualifying for the refinanced loan you need. For that reason, the new mortgage rules might actually end up costing you a significant amount of money over the life of your loan because you won’t be able to refinance your loan at a lower rate due to the mortgage stress test.
There is one exception—if you refinance with a private lender that isn’t regulated by the government. But while they aren’t required to do the stress test, private lenders often charge higher interest rates.
What Happens If You’re Renewing Your Mortgage?
Luckily, the stress test doesn’t technically apply when you’re renewing your mortgage. That means continuing with the same (or similar) terms with the bank that gave you your mortgage in the first place.
However, sometimes it’s not the best financial choice to renew your mortgage because you might find a lower rate elsewhere. In that way, the new mortgage rules make it even more important than ever to shop around for the best mortgage rate.
One of the most efficient ways to ensure you get the most competitive mortgage rate available is to use an online mortgage broker. For convenience, Breezeful stands out for a number of reasons. It’s easy to use and incredibly fast. Once you complete your online application, you will receive rates from more than 30 banks in just a few minutes. Users also like the fact there is a mortgage expert available to walk you through the entire process, making finding the best rate for you stress-free.
One more note: Just because a bank doesn’t require a stress test when you’re renewing your mortgage doesn’t mean that they won’t do it anyway. Some banks are using the stress test with all clients just to be cautious.
Does the Stress Test Apply to All Mortgage Lenders?
No, credit unions and private mortgage lenders in Canada aren’t required to conduct a stress test with their borrowers. For instance, credit unions will qualify you for a mortgage based on their actual rates rather than the higher rates required via the stress test process. This might sound like a win, but remember that a credit union or private lender may not offer the lowest interest rates on the market – which could also restrict your buying power.
Finding the Best Mortgage Rate
Since interest rates are constantly fluctuating, your best bet is to shop around for the most competitive mortgage rate before signing on the dotted line. Different institutions offer different interest rates, but a good place to start is the best online mortgage lenders in Canada. An online mortgage broker typically offers the most competitive mortgage interest rates in the market, and you can do the entire application online.
When it comes to getting a mortgage in Canada, it’s definitely harder since the mortgage rule changes were introduced. But it’s not impossible. With a few financial tricks and the right saving strategies, there’s no reason to give up on your dream of home ownership. Keep saving for a down payment and maintain a good credit score, and you’ll be unlocking the front door to your new house in no time.