In this week’s article, I wanted to take some time to give everybody a mortgage update because OFSI just passed the B-20 guidelines. This is going to have a major impact on the state of the real estate market – much bigger than the minor interest rate hikes that we saw a few weeks back. Before you read on, please remember, I am not a mortgage broker so as you read this article, keep in mind that it is from the perspective of an investor and realtor.
One of the major guideline changes proposed by OFSI is having conventional mortgages tested 200 basis points (bps) above the posted rate. If the previous sentence was a bunch of gibberish to you, don’t worry, I’m going to break it down for you below. As usual, I’ll give you a bit of background before it gets more “nerdy”.
Some Background Info: OFSI is the Office of the Superintendent of Financial Institutions (pronounced “off-see”). They are an independent agency of the Government of Canada reporting to the Minister of Finance created “to contribute to public confidence in the Canadian financial system”. Basically, it is a group of people who have the ability to implement regulatory changes that can affect the Canadian financial system.
– A conventional mortgage is your standard mortgage that most people use, which comprises of a 20% down payment on a variable rate based mortgage.
– At 20% down payment, you do not need to get mortgage insurance (CMHC). It is only required for mortgages with less than 20% down payment.
– When you need mortgage insurance (<20% down payment), you are required to go through the stress test as per the OFSI rules in October 2016.
– The Stress test is a test that your lender will conduct on your application to make sure that you can make your mortgage payments if the interest rate goes up by 2%, hence 200 bps. Each basis point is 0.01%. Our last interest rate hike was 25 bps, so 0.25%.
So with the background out of the way, let me give you my thoughts on how the new B-20 guidelines when they are in effect January 1st, 2018.
To keep this insight short and sweet, the last OFSI change in October required those with less than 20% down payment to go through the stress test and as a result, they lost about 20% of their borrowing power. If they were previously pre-approved for a one million dollar purchase, they could only afford $800,000 afterwards. You were basically immune to that stress test as long as you had 20% down payment (which most people did have).
The New OFSI Rule: With this new OFSI B-20 change, EVERYBODY will have to go undergo the stress test. Ultimately, it will reduce the buying power of the entire Canadian population, but Torontonians and Vancouverites will likely see the bulk of the impact.
Have a look at the chart below (Courtesy of our friend Scott Dillingham from CIBC Mortgages) to see what kind of buying power you will have after the new rule changes. The chart below is a general guideline as everybody’s situation is different. Please keep in mind that this is one scenario. If you have higher credit score and lower debt, you could potentially borrow more. From Scott’s chart below, everyone will lose approximately 14% of their total buying power.
So how does this affect YOU? If you are in the market and/or will be looking for a property in the near future, be prepared to be able to borrow less money. In turn, this means that you will essentially be able to afford less, especially if you’re just getting started with your first property. If you will be closing within the next 60-90 days, I know a few banks and brokers that will honour their mortgage commitments even after the guidelines get passed. Let me know if you want to chat to some of these people and I’ll be more than happy to connect you.
To my fellow investors, be prepared to come up with a higher down payment for your property when you get stress-tested. I suggest that when you are about to close, take a Home Equity Line of Credit (HELOC) on one of your existing properties in preparation for the closing.
How will this affect the market? We have to think about what kind of cascading effect this will have. When the first stress test was passed last year, we saw a lot of people forced to reduce what they could afford.
The one million dollar buyers ended up with $800,000 and went from a detached to a semi-detached or townhouse at that time in the market. We are now seeing the $800,000 buyers go from a townhouse to large condo.
With this change happening, we’re likely going to see a similar shift in the market again. Ultimately, I don’t think this is going to be good for the real estate market as it will put downward pressures on the most affordable real estate class (i.e., condos) – as if the condo market wasn’t already hot enough right now! The resale and new condo market will likely experience an increased demand in addition to the massive demand that condo rentals have seen in the last two months. In other words, you may want to consider purchasing condos for investment purposes sooner rather than later.
The photo below (Courtesy of Better Dwelling) shows the average median income against average price home in each area. The blue boxes means the income in that area can afford the house. Red means it cannot. Have a look at what the new B-20 guidelines may do to affordability.
Remember, OFSI creates these guidelines for consumer confidence and currently, they believe that the Canadian debt level is way too high. The crazy thing about this perspective on Canadian debt is somewhat silly when you’re a home owner. Your debt level, whether you own a home, lease a car, or rent is all calculated the same way according to OFSI. Can you really compare a person renting and leasing a car to a person who owns their property? The property owner will almost certainly have more debt than the person who rents and leases a car, but who do you think is likely doing better financially? In both situations, if they can’t make their rent or mortgage payments, at least the homeowner has a hard asset that they can fall back on. What can you fall back on from the person renting and leasing a car?
Final Thoughts – I really feel for the people who are trying to get into the market and have every intention of being a homeowner. However, some of these people just keep encountering hurdles when trying to buy their first home, despite how hard they are trying to save. Although the government is creating all of these rules to make owning a home so much more difficult and pushing everyone to be renters with their other interventions (i.e., fair housing plan), you can ultimately view this two ways:
1. The first is to just throw up your hands, give up and be renters for life -because owning a property is simply just too difficult now
2. This is an opportunity to benefit from the increasing number of renters and the increased demand for a good condo unit in a good area.
Personally, I think the second perspective will take you much farther ahead of the pack than the first. So what will you do during these changing times in the mortgage landscape?
Until next time, Happy Real Estating,