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The government has dealt a shocking blow to the real estate market

canadian-governmentShould first time home buyers act now or wait for a correction?

If you thought it was hard to qualify for a mortgage before today, you are going to be in for a big surprise if you wait even a few weeks before taking the plunge. Effective October 17th, 2016 all insured mortgage applications will have to pass a very tough “stress test” before being approved.

There are other changes in the offing – surrounding income tax rules and home ownership. Here is a link to the Official Ministry of Finance announcement.

Till now, as long as you selected a five year or longer, fixed rate mortgage, your lender would calculate your debt service ratios using the actual contract interest rate. These days that is anywhere from 2.29% to 2.59% for most AAA borrowers.

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However after October 17th, these same debt service ratios will be calculated AS IF YOUR MORTGAGE INTEREST RATE IS 4.64%.

This could have the effect of reducing the amount of mortgage high ratio buyers can qualify for by more than 20%! 

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IN PLAIN TERMS THAT MEANS HOUSING HAS JUST BECOME OFFICIALLY UNAFFORDABLE FOR THOUSANDS OF BUYERS

The rationale is the government wants to be sure that borrowers can withstand an increase in mortgage rates by the time their mortgage comes up for renewal in five years’ time.

All applicants with a down payment of less than 20% have high ratio mortgages; these are insured and they must now pass the stress test.

In addition, there are many lenders (we call them monoline lenders and are available through mortgage brokers) who insure most of their mortgages even when they are low-ratio mortgages – that is where the down payment is 20% or more. Starting November 30, 2016 such low-ratio mortgages must also pass the stress test.

In Canada we have three mortgage insurers – Canada Mortgage Housing Corporation (CMHC) Genworth, and Canada Guaranty – I am sure they will all be equally affected.

What does this mean for the immediate future?

We might see a flurry of purchase transactions and mortgage applications over the next two weeks. This might create a temporary bubble in housing prices. Or maybe people will just throw up their hands and wait it out.

When the rules kick in on October 17th, there will be buyers left on the sidelines, suddenly unable to qualify for a mortgage. The majority of high ratio purchases are first time buyers, so we can expect many of them to be shut out of the market.

  • First time buyers will be forced to look at homes costing significantly less than they were planning to purchase. This could apply downward pressure on home values.
  • There will be more demand for low end housing – the condo market may benefit from this as they are typically cheaper than single family homes.
  • With fewer first time buyers entering the market, this will have a trickle-down effect on move-up buyers. Before you move up to your next home, you need to sell the one you have got!

Over the last several years I have marveled at the sheer strength of our real estate market. Past efforts by the federal government to intervene and slow the pace of growth down have been brushed aside by the market.

However, I can’t help but feel our Finance Minister has gotten a bit carried away with this new legislation. It’s hard to picture any near term scenario other than suddenly dropping demand and home prices.

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Most likely the pendulum is about to shift pretty quickly and we may go from a sellers’ market to a buyers’ market in one fell swoop.

Toronto underwater mortgageYou can argue a market correction will ultimately be good for us all, as prices come down, housing will be more affordable for more people. But spare a thought for all those high ratio buyers of the last six months who may soon find their new home is now “under water” and that their mortgage balance is larger than the current value of their home.

So what should first time buyers do now? Jump in immediately while they still qualify for a mortgage, or gamble that prices will correct – maybe significantly, and then enter the market? We will see.

Personally I have learned over thirty years in financial services it is usually folly to be a market timer; whether it’s real estate, stocks or whatever. And I have absolutely no worries about the long term health of the real estate market in Canada – and in particular Toronto and Vancouver. These are world class cities which will always be in demand and which beat to a different drum than everywhere else.

 Related article :Four major changes to Canada’s mortgage rules the Globe and Mail, October 04, 2016

Related article : Is this the last nail in the coffin?, Rob McLister, Canadian Mortgage Trends, October 04, 2016

The last word from Rob McLister “With mortgage tightening finally starting to impact high-valued markets, this new round of rules has come too late, with too little forethought and too many consumer repercussions. Its effects are so wide-reaching, so sudden, that something has me thinking it’s a conspiracy against non-bank lenders.”

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