In late 2016, the federal government drastically shook up many home buyers’ plans by introducing the much-loathed mortgage stress test. The new rule requires real estate buyers spending less than 20 per cent down to qualify at a rate of 4.64 per cent — nearly double the lowest fixed rates available.
To say this caused some angst, especially among newbie buyers, would be an understatement. In fact, according to a recent study by the Ontario Real Estate Association, as many as eight in 10 first-time buyers have been impacted.
But this was only one of two changes passed by the Department of Finance. The second has comparatively slid under the radar — but could prove just as impactful for affordability. This second rule targets the banks themselves, namely how they fund new mortgages and set their pricing.
As of Nov. 30, lenders must apply the same high-ratio mortgage rules to low-ratio mortgages within their portfolios in order to insure them. But what the heck does this mean — and how does it trickle down to consumers’ wallets?
What high-ratio means for consumers and banks
Let’s start with the difference between high- and low-ratio mortgages. When a buyer pays less than 20 per cent on their home purchase, they’re considered to be a higher-risk borrower; with less capital upfront, and a greater debt-to-equity ratio, the chances of them defaulting on their payments are higher. These buyers are required by law to purchase mortgage default insurance, supplied by either the Canada Mortgage and Housing Corporation or via private insurers Genworth Canada and Canada Guaranty. The home buyer is on the hook for the cost, which is rolled into their mortgage payments. As well, this high-risk profile limits the type of properties they can get mortgages for, including:
- rental properties,
- homes priced over $1 million
- mortgages with an amortization of over 30 years
- mortgage refinances
If you pay more than 20 per cent on your home purchase, you’re considered a low-ratio buyer, and are exempt from these limitations and the need for insurance. Lenders, however, often choose to insure the low-ratio mortgages in their portfolios anyway, as that allows them to bundle them up and sell them as investments. These mortgage-backed securities (MBS) are an important funding method for lenders, especially smaller ones that may only offer mortgage products.
The Big 6 use MBS too, but have the benefit of more diversified deposit business and deeper coffers.
New mortgage rules hit banks in the moneymaker
Under the new mortgage rules lenders can’t use the above mortgage types in their MBS, and that’s a hit to their bottom lines. It’s now more expensive for them to offer mortgage products.
But don’t feel too sorry for them — after all, borrowers will be picking up the tab. Banks will pass these higher costs down in the form of higher fixed-mortgage rates or could stop offering these low-ratio products altogether.
That limits choice for the consumer and competition in the marketplace; for example, those who need to refinance their mortgage (25 per cent to 30 per cent of all mortgage consumers) may need to switch to another lender, or won’t have the option easily available to them should they need to rework their household debt.
Higher fixed-mortgage rates to come
What’s more likely, though, are just higher prices for these products. Lenders were swift to price in a 15 to 30 basis-point premium for them by last year’s end. It has also been reported that TD’s surprise prime rate increase in early November is a make-up for their limited MBS options.
While a 15-basis point hike won’t make or break a mortgage — your payment will only rise by a few dollars each month — there could be more to come. A pending proposed risk sharing plan could also increase the banks’ costs in the months to come.
That’s why it’s more important than ever for mortgage shoppers to know how the options offered by various lenders differ, and compare the market when searching for their home financing.