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What the New Mortgage Stress Test Means for First-Time Home Buyers

May 27, 2021

In the runup to June 1, many Canadians may be in a mad dash to buy a home and secure a mortgage rate before the new stress test comes into effect.

On May 20, the Office of the Superintendent of Financial Institutions (OFSI) announced that come June, uninsured borrowers will face an increased mortgage qualifying rate to ensure that they can handle their payments if rates go up.

According to the new rules, borrowers must be able to carry payments at the contracted mortgage rate plus 2%, or at an interest rate of 5.25% – whichever is higher.

Though the OFSI announcement set the new rule for uninsured mortgages – where the buyer has more than a 20% down payment – the Federal Government’s Department of Finance extended the policy to insured mortgages, where the down payment is less than 20%.

Since most insured mortgages are held by first-time home buyers, we’re taking a look at what the new stress test means for them in an already challenging market.

Stacked blocks representing rising mortgage qualifying rates

The mortgage stress test keeps buyer’s best interest at heart

In a press statement, Bank of Canada Governor Tiff Macklem outlined that the new stress test comes in response to a “key vulnerability” in the Canadian economy that’s putting home buyers at risk, caused by “imbalances in the housing market and high household indebtedness.” The aim is to protect buyers from getting in over their heads during uncertain times.1

Because of the ultra-low interest rates meant to stimulate the economy during the pandemic, Canadians have been flocking to purchase properties better suited to life at home. But with supply levels running painfully low in markets across the country for most of the last year, intense buyer demand has driven the national average selling price up by almost 42% since April 2020.2

Macklem notes that, as a result, “people are rushing to buy partly because they expect prices to keep rising. This behaviour can exaggerate near-term house price increases.” He also points out that such rapid price hikes “are not normal,” and that if the factors that caused them were suddenly reversed – like demand drying up due to rising interest rates or another economic downturn – home prices could plummet. That, he says, “could leave some households with less equity in their homes.”

Another concerning factor cited by Macklem is that many Canadians have increased their debt load through the pandemic, which makes them more vulnerable if the market should take a turn for the worse.

Essentially, buyers could find themselves in hot water if much of their income is tied up in non-mortgage debt when their mortgage term ends and they're forced to refinance at a higher rate. 

Stormy skies above a house

A perfect storm

If interest rates go up, selling may be the only option for those who can't afford to make their payments. However, if home prices have fallen as a result of overheated markets, these buyers could find themselves in the unenviable position of selling their homes for much less than what they paid. Likely, this would leave them still owing money on homes they no longer own.

According to Macklem, it’s the responsibility of lenders and individuals to avoid any of the three scenarios – that rapidly rising prices could amount to a bursting housing bubble, that high debt-to-income ratios could leave Canadians unable to pay their mortgages, and that a combination of both could divest people of their homes and leave them financially crippled.

By ensuring that buyers can handle increased interest rates, the stress test protects buyers’ ability to afford their homes, which would allow them to at least hold onto their properties if prices were to go south.

The short-term effects

Despite the good intentions behind the mortgage stress test, things could get harder for first-time buyers before they get better.

As it is, buyers are required to make a minimum down payment of 5% when the mortgage is for $500,000 or less. Anything over that amount requires a down payment of 5% on the first $500,000 and 10% on the remainder.3

But, according to the Canadian Real Estate Association’s latest stats, the national average selling price (which can vary dramatically from region to region) was a little under $696,000 in April 2021.4 Thus, the average down payment for a first-time buyer would already be $44,600 – quite a feat for anyone to tuck away and that’s still considered a high-ratio mortgage requiring mortgage insurance.

Under the new stress test, first-time buyers will not only be required to pony up terrific sums, but they’ll have to demonstrate that they can carry high-interest payments for the duration of their mortgage term. If neither is possible, they’ll either be sidelined as they continue saving or have to settle for a smaller loan, as many industry experts agree that buying power for insured and uninsured borrowers will be reduced by 4-5%.

Of course, on the flip side, qualifying for a mortgage that’s 5% lower isn’t a tremendous change. To continue using the national average home price as a benchmark, buyers who could today be approved for a mortgage on a $696,000 house might, after June 1, be approved for a loan closer to $660,000 – hardly enough to dramatically affect one’s standard of living.

Small wooden house placed on an open laptop representing the search for a home

The longer-term effects

Though certainly a bitter pill to swallow after months of what seemed like easy money, the stress test could benefit first-time buyers down the road – and not just by protecting them if housing interest rates go up. By reducing the number of qualified buyers competing for limited inventory, the market is expected to cool. Price increases are expected to slow, and this, in turn, will give first-time buyers a better chance of jumping in when the time is right.

Though the change is coming fast, local Purplebricks REALTORS® are equipped with the knowledge and experience to help you reach your real estate goals. Plus, when you buy with one of our agents, you’ll receive $2,000 cash back* as a thank you! Sellers can also reap the rewards by working with a team of specialized REALTORS® and saving thousands in commission. Call 1-855-999-9740 to speak to an associate today.