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Buying a home is one of the biggest financial decisions you will make in your life. Let’s have a look to see if you are financially ready for a mortgage or if the changes in the Stress-test might have an influence on your readiness.

Last week the Federal government announced that on April 6,2020 it will change the way the Bank of Canada (BoC), calculates the stress-test rate that lenders use to qualify all insured mortgage applications.

How does is work currently?

  • The term ‘insured mortgage’ refers to any mortgage where either the borrower or the lender pays for mortgage-default insurance.
  • Borrowers who are purchasing a property with a down payment of less than 20% must purchase mortgage-default insurance. (When the down payment is 20% or more, the borrower and/or the lender has the option for purchasing default insurance (to lower the interest rate).
  • If a borrower applies for an insured mortgage today, that comes with a rate of 2.69%, they must qualify using the current stress-test rate of 5.19%.
  • Last week’s announcement applies to only insured mortgages.

How will it look as of April 06, 2020?

  • Today the insured stress-test rate is calculated using the mode of the Big Six Bank’s current five-year posted rates. The current methodology is flawed because the Big Six don’t actually lend at their posted rates, and they don’t adjust them dynamically in response to market changes. (A recent example: average five-year fixed rates have fallen by nearly 1% over the past 12 months, and the stress-test rate has only decreased from 5.34% to 5.19% over that same period)
  • Effectively April 6, the stress-test rate for insured mortgages will be set each week by adding 2% to the average interest rate on insured mortgage applications over some prior period.

Let’s have a look at some observations relating to this change and how it will likely impact borrowers:

  1. This change will likely hurt affordability in our hottest real-estate markets over the short term. At first this statement may seem counterintuitive. If the stress-test rate drops from 5.19% to 4.89%, shouldn’t that improve affordability? In theory, Yes. but if there are 5 bidders for a property and they can all suddenly increase their maximum mortgage amount, the price of the property is likely to be pushed higher, and that will make it less affordable to whoever makes the winning bid.
  2. The stress-test rate will be more dynamic, but also more volatile. the stress-test calculation tweak is a welcome change because it ties this benchmark directly to real market rates. But that will also make it more volatile. Stretched borrowers, who are pushing to buy at the top of their affordable price range, run the risk that a property they can afford one week, becomes unaffordable the following week, if the stress-test rate edges up.
  3. The new stress-test rate will increase transparency. The stress-test rate will be calculated by taking the average interest rate of the mortgage applications received by all three of our default insurers (CMHC, Genworth and Canada Guaranty). Borrowers will be able to compare the rate they are being offered against the average to see if they getting a good deal.

While this long overdue change will likely reduce today’s stress-test rate from 5.19% to 4.89%, it will also likely decrease affordability over the short term and make the stress-test rate more volatile going forward.

Surprisingly, about two-thirds of Canadian mortgage borrowers still walk into the bank that handles their daily banking, and many accept whatever they are offered without seeking alternatives and this can be an expensive mistake. If you are interested in buying a property, don’t delay, contact one of our experienced brokers to see what you would qualify for.

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