Watch out for Mortgage Regulation Part 2
On January 1st, the federal banking regulator required all banks to implement stress tests. This is relatively old news and we know that it reduces home buying budgets for middle class families by about 20%. This is intended to lead to a soft landing in the real estate market.
What if prices continue upward?
The stress tests were part of a package of regulatory updates to bank lending guidelines that roughly fall into two categories:
1. Borrower’s ability to make mortgage payments
2. Value of the property being mortgaged
#1 asked lenders to be “rigorous” when reviewing documents that verify a borrower’s income, and it required lenders to apply the stress test to make sure borrowers could handle a 2% rate increase. This is relatively easy to understand, affects middle class families, and has an immediate measurable impact.
#2 hasn’t been talked about much in the media but it will likely rear its head later this year, especially if condo prices continue to climb in Vancouver and Toronto. It asks lenders to incorporate property valuation risk into their lending guidelines and make “adjustments”. What the heck does that mean!?
Property Value Risk Adjustments
Under normal market conditions, a typical bank will lend you $80 for every $20 you put into a home purchase. In other words, they loan you 80% of the value of the property (loan-to-value).
The regulator has told banks to assess the risk of each market where they do business and rate the property value risk (i.e., the risk that property values could drop). The regulator stipulates that “rapid house price appreciation” be a consideration for defining higher property value risk. The figure below shows how CMHC rates the riskiness of Canadian real estate markets.
The regulator then says they expect banks to “adjust” their loan-to-value based on property value risk. Yes, very unexciting regulatory language. They simply told banks to apply lower loan-to-value in markets with higher risk which will impact mostly upper middle-class families.
The regulator left it to each bank to figure out how to comply and they will likely make small adjustments at first. It’s difficult to get excited about this when we don’t know how banks will implement this change. But an illustration where the banks reduce their loan-to-values by 10% in Toronto and Vancouver may help get the point home.
Drop in Allowable Loan-to-Value (LTV)
If you have a high household income, then the stress tests may not impact you but the implementation of the LTV guidelines may cost you dearly.
The example below assumes a couple of teachers making $60k each have just inherited $150k and want to buy a starter home worth $640k. They make enough money to get a loan of $515k, but the 80% LTV guideline caps them at $512k to buy this home.
Let’s assume the banks use the CMHC risk assessment that identifies Victoria, Vancouver, Saskatoon, Hamilton, and Toronto as high-risk markets and decide to only loan 70% LTV in those cities. Overnight, the maximum allowable loan for the home is $448k regardless of one’s ability to make the mortgage payments. The $150,000 inheritance is no longer enough to buy the $640k starter home and makes it necessary to look for something cheaper.
The LTV changes are designed to reduce the risk of financial loss for banks if prices were to drop, but they also remove home buyers with higher household incomes from the market who weren’t impacted by the stress tests.
What to do?
These LTV measures may not impact you but if you are intent on buying in 2018 then you may fare better in the first half of the year just in case. Provincially regulated lenders, including Credit Unions and private lenders, are not required to apply the stress test or the LTV guidelines. The media refers to these lenders as “shadow lenders” but there’s nothing shadowy about them. They are regulated by respected provincial regulators like FICOM and FSCO and must adhere to high professional and risk standards.
To get access to experts who know what every lender is doing, consult a mortgage broker. They have the broadest number of options to find you suitable financing.
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