Here's what it all really means.
As of January 1, 2018, you will need to pass a new “Mortgage Stress Test” (MST) to qualify for a mortgage loan at a bank. And it won’t matter how much you have to put down. Even if it’s 20% or over, you’ll still be subject to the MST . Once you pass the test, you’re not required to actually make a 20% down payment - you can still take advantage of a lower one and a lower mortgage rate. But first you have to pass 'the test'.
BREAKING IT DOWN
The Government wants you to prove you can afford payments at a higher interest rate than the actual rate in your mortgage contract.
The Mortgage Stress Test (MST) has been typically applied to insured mortgages, in which the borrower had put down less than 20% towards their down payment. But now it's for everyone applying for a mortgage.
Guess what? Credit unions are not bound by the new rules but that may change as they've historically followed the banks in the past.
This stress test will automatically reduce everyone’s borrowing capacity by a minimum of 18.5%.
The larger the gap between your pre-approved interested rate and the stressed rate will further impact/reduce your borrowing capacity.The main effect will be felt by 1st time buyers because no matter how much money anyone puts down, they still have to pass the stress test.
WHAT ARE THE NEW QUALIFYING RATES?
The new qualifying rate for uninsured mortgages (ie with 20% or more down) is ‘the greater’ of the Bank of Canada’s present 5-year fixed rate of 4.99% OR 200 basis points above your contractual mortgage rate. So if you’ve been awarded a 3% mortgage rate, you now have to ‘qualify’ for a 5% one. If it's 3.2% your qualifying rate is 5.2% and so on.
Even if you were pre-approved at 2.49%, your mortgage would now be subjected to a stress-test against a rate of either 4.49% (current rate +2%), or against the posted rate of 4.99%. Since the posted rate is higher, this is the rate that will be used in the stress test.
IS THERE ALREADY A LOOPHOLE TO HELP?
There may be. Currently, the new rules don’t limit the number of amortization years. Extending the amortization from 25 years to 30 or even 35 years returns about 18% purchasing power back to you, the Buyer. We will have to see the final decision, though. Note: there are only a few banks which offer 30 or more amortizaiton years and they do charge a slight rate premium.
THERE'S A LOT MORE THAT MAKES UP THE ‘MORTGAGE STRESS TEST?
To a lender, affordability translates into two things: Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS). GDS and TDS are two mortgage formulas that lenders use to determine exactly how much money they are willing to lend you.
As of January 1, 2018, the maximum GDS (Gross Debt Service) ratio is 39% and TDS (Total Debt Service) is 44%. (Note: while the guidelines state your GDS should be no more than 32% and your TDS should be no more than 40%, most borrowers with good credit and a reliable income will be allowed to exceed these guidelines. The maximum GDS is 39% and the maximum TDS is 44%)
What is Gross Debt Service (GDS)?
A GDS ratio is the percentage of your income needed to pay all of your monthly housing costs, including mortgage payments of principal, interest, taxes, utilities, and real estate taxes.
You’ll also need to include 50% of your condo maintenance fees, if applicable. Your GDS has to be 39% or lower to qualify for the mortgage.
To calculate your GDS ratio, you’ll need to add all of your monthly housing-related costs and divide it by your gross monthly income. Then multiply that sum by 100 and you’ll have your GDS ratio
What is Total Debt Service (TDS)?
Your TDS ratio is the percentage of your income needed to cover all of your debts. The debt ratio formula calculation is the same as one for the GDS, except all of your monthly debts are taken into consideration. This includes car payments, credit cards, alimony, and any loans. Your TDS has to be 44% or less.
To calculate your TDS ratio, add all of your monthly debts and divide that figure by your gross monthly income. Then multiply that sum by 100 and you’ll have your TDS ratio.
Your GDS and TDS ratios allow lenders to know if your income will cover the costs of your mortgage. If your GDS & TDS are higher than 39% and 44%, respectively, try and lower your debt before seeking out an alternative lender. Those lenders will likely have higher interest rates plus higher loan fees. No lender is judging whether or not you deserve a home; they’re looking at you as a potential risk and calculating that they can collect the money you’ll owe them. Over the long-term.
In addition to the GDS and TDS figures there are other basic expenses like transportation and food. So you want the ratios to be as low as possible to account for these other costs.
WHAT CAN YOU DO TO LOWER YOUR GDS/TDS RATIOS?
- TDS/GDS: Make a greater down-payment, which decreases your mortgage debt and monthly mortgage costs.
- TDS/GDS: Increase your (gross) household income.
- TDS only : Reduce your current debt obligations (such as car payments, credit card interest, pay down/off credit cards)
THE TIMING DETAILS
- Prior to January 1st: If there is a firm Agreement of Purchase and Sale contract in place prior to January 1st, then all lenders will be honouring the “old” rules. But not after January 1st. But there is one lender that is honouring these old rules for 120 days, to allow Buyers to purchase and close prior to the end of April. Of course, this is if you've qualified and have a pre-approval in place prior to Jan 1st with this specific lender.
- If someone applies for financing after January 1st, BUT has a firm Agreement of Purchase and Sale contract in place before this, they DO NOT have to qualify under the new rules. They qualify under the old rules – they are grandfathered.
WHAT IF WE'RE REFINANCING?
If, on renewal, you stay with your existing lender, then you don’t have to pass the stress test again However, if you change lenders at mortgage renewal time, you may have to qualify and pass, but it’s not yet clear if this will be the case Lenders are thrilled about one thing: customer retention. As many as one in six people, renewing their mortgage, could be trapped at their existing bank because they can't pass the stress test at another lender. And if a bank knows you can't leave, it may very well offer sub-par rates.
WHAT’S THE REAL BUYING POWER DIFFERENCE?
SCENARIO 1: Prior to January 1st, 2018
A family has an annual income of $150,000. They've been approved for a 5-year fixed mortgage at 2.69%, with 20% down amortized over 30 years.
They can afford a purchase price of $1,000,000.
SCENARIO 2: After January 1, 2018
This family’s income is still $150,000. They have been offered a 5-year fixed mortgage at 3.34%, with 20% down amortized over 30 years. Because it’s less than 4.99%, 200 points must be added and their new qualification rate is 5.34%.
They can afford a purchase price of $804,520.
This is an affordability difference of $195,480 (less 19.458% than in 2017)
With sincere thank you's to:
Ben Poulin, CIBC Imperial Service Financial Advisor
Caryn Negin, Mortgage Agent, Dominion Lending Centres
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