New Canada Mortgage Stress Test Changes: How It Will Impact The Toronto Real Estate Market!
Introduction
By now, you’ve probably heard about the changes to mortgage stress tests, making it harder to qualify for larger loans, which was announced back in April and starts this June. Instead of limiting the upward on the Canada real estate market as a whole, this might result in buyer demand getting redistributed instead.
In this video, we’ll explain what’s changing and discuss the types of Toronto real estate that might get more popular after this change, and what properties might get impacted downwards.
Changes To Canada's Mortgage Stress Test (June 2021)
As a quick recap, here’s what’s changing starting June 1. OSFI the biggest bank regulator in Canada is enforcing stricter mortgage stress tests for major Canadian banks. OSFI feels that the housing prices have been going up too quickly and so they’re making this change with the objective to reduce the lending risk for banks.
If you’re not familiar with what a stress test is, a stress test is a method that banks use to figure out how much they can lend you by looking at your ability to pay back the loan under extreme situations.
A popular way is to use the Gross Debt Servicing (GDS) Ratio and the Total Debt Servicing (TDS) Ratio, which looking at how your income covers your new mortgage and expenses plus other existing debt and expenses.
When banks calculate your new mortgage, they don’t look use the interest rate they give you in stress testing but rather a higher worse case sense rate to check that you can still pay for your mortgage even if rates increase. So even if you’re getting 1.9% for your new mortgage, the rate they use for the stress test is actually the higher of your actual mortgage rate + 2% or their preset stress test interest rate.
Now, here’s where things are changing. The preset stress test interest rate is increasing. It used to be 4.79% and now it’s moving up to 5.25%. So effectively, this bumps up your debt and your GDS and TDS ratios, which simply means you’ll be able to qualify for a smaller mortgage after the change. After the change, your lending power will decrease by around 4.5%, which might put the brakes on real estate price growth.
CMHC Mortgages
Note: A recent update shows that CMHC mortgages will also follow this change.
Typically, those who get CMHC mortgages are those who need more help with coming up with a downpayment for a property. Requirements for a CMHC mortgage are that the property needs to be under $1 million dollars, the borrower need to meet certain lower income requirements, and the property needs to be an end user home.
What’s interesting is that even though the stress test is getting stricter, CMHC mortgages are also getting easier to qualify for in Toronto. Before this spring, the maximum income that can qualify for CMHC loans was $120,000 and you can borrow up to four times your income. Now, it’s upped to an income level of $150,000 and 4.5 times, which means you can now qualify for a maximum loan of $675,000 instead of just $480,000 in Toronto.
High New Worth / Income Mortgage Programs & Exceptions
Another important thing you might not know is that stress testing based on income and debt isn’t the only way you can get a mortgage with a bank. Banks want to make sure you can pay for your mortgage, so if you’re a high net worth individual, you typically get bonus points. What this means is that you’re not limited to the basic programs from the bank, but you might qualify for some other mortgage programs.
There’s the liquid asset high net worth program, where banks can offer you a mortgage based on the amount of liquid assets you have. For example, if you have at least $250,000 in liquid assets, banks can offer you a loan at a ratio of one-to-one, so you can borrow an extra $250,000 and these programs can be used in conjunction with their traditional programs as well.
There’s also modified income programs out there that makes is easier to qualify for loans even with this higher stress test interest rate and these are also typically accessible for higher net worth people.
For example, Scotia has a special program where they actually increase the TDS threshold from from around 44% to 50%. So even though the increases your debt by 4.5%, the bar is moved 13% higher, so effectively you might even be able to qualify for a slightly bigger loan under this program.
Finally, instead of using the GDS / TDS method, there’s also the Debt Covering Ratio (DCR) method to qualify mortgages. Those who qualify for this method typically already own a few cash-flowing investment properties and so instead of looking at your personal debt along with your investment properties, your investment properties form an portfolio entity on its own. What this means is that even though you still have the higher stress test rate, your personal debt isn’t included in the entity’s stress test so you might be get a bigger mortgage using this method.
How The Stress Test Affects End User Buyers
Now that you have a more complete picture of what’s happening in the mortgage world, this perhaps might change your view on how this new stress test might affect the housing market. For end user buyers, this stress test change really impacts the middle class the most:
- There’s programs available for the high net worth, so there is likely a work around.
- On the other hand of the spectrum, CMHC mortgages are getting easier to get, so more people might start going through the CMHC mortgage channel and see a bigger bump in demand for properties under $1M.
- And so, we’re left with the middle class begin most affected. Right now, middle class homes in the GTA are likely over $1M now so this stress test directly applies to these homes, and the growth of middle class end user homes in the GTA will be limited because of the change.
How The Stress Test Affects Investor Buyers
Interest from real estate investors has not diminished because of this change – investors are still interested in buying real estate and the numbers are still attractive to them and it’s really all about the numbers.
While it’s great to buy a triplex that offers slightly better rent yields which can maximize investment returns, a single family home with an extra basement apartment is pretty good too. If we’re looking at a 0.5% lower rent yields at 4 times leverage, that’s only a 2% difference in ROI after leverage. And if that 2 unit home has better appreciation potential or better value add opportunities, it might even be a better investment.
What we do see is that positive cash flows continue to be an important priority for real estate investors. Better rental income can help qualify for bigger mortgage and compensate for harsher stress testing requirements, but the more important theme is that it gives better holding power and a buffer especially in increasing interest rate environments which most people are factoring in now. So even though they might look for properties at lower price points, the choice is still freeholds with positive cash flows over condos.
How Demand May Shift From The Stress Test Change
When you put all this together, here’s where the higher demand might be at in the short term. Lower priced freeholds, especially those under $1M who also see increasing demand from CMHC end user buyers, with strong rent yield potential and strong appreciation potential might attract more demand than everything else.
Right now, the pockets we invest in Toronto does fit this criteria and we have been seeing better rent yields compared to the rest of the GTA. On the leasing end, we’re seeing early stages of rental demand picking up, and that points to rent prices slowly recovering. Going along with the same recovery story, we also expect Toronto property prices to benefit most as our economy recovers and immigration picks up again.
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