Ottawa Tightens Mortgage Rules to Cool Housing Markets

Ottawa is acting to curb risks in the housing market, unveiling new measures to crack down on speculation and make it harder for homeowners to take on unaffordable debt. And while the moves are aimed primarily at the overheated Vancouver and Toronto markets, the new rules are likely to affect all home buyers.

It used to be that anyone who sold their principal residence in Canada didn’t have to report the sale — or the profit from it — to Canada Revenue Agency (CRA) as long as they were living in the home.

But that’s changing. Under new rules, taxpayers who claim an exemption from capital gains tax when selling their home will have to report the sale on their tax returns. The CRA will examine tax forms to verify that the beneficial owner of a property lived in Canada and was living in the home.

Families will be allowed to claim an exemption on only one home a year and the home’s owner must live in the property. Capital gains must be paid on the sale of secondary properties, such as cottages and homes that are used as a rental property to generate income.

The change was spawned by concerns that speculative investors, particularly from abroad, are buying and flipping homes in Canada for a quick profit. Moreover, to avoid paying taxes, they’re falsely claiming the primary residence exemption without actually living here.

As a result, many families have taken on high levels of debt to buy a home before it’s too late. Two more changes targeting the mortgage insurance market are aimed at stopping that.

“Stress Test”

First, starting October 17, a mortgage stress test is being expanded to cover all insured mortgages — including those where the buyer has a down payment of more than 20%. The test is aimed at ensuring that home buyers will still be able to afford the mortgage if interest rates rise, or if their income drops. Currently, stress tests aren’t required for fixed-rate mortgages longer than five years.

While many buyers are currently qualifying for five-year mortgages at around 2%, they’ll now have to prove that they can make mortgage payments at the Bank of Canada posted rate of 4.64% — which, in heated markets such as Toronto or Vancouver, can add tens of thousands of dollars a year in interest charges.

Existing rules require home buyers who take out short-term or variable-rate mortgages with down payments of 20% or less to prove they can afford payments at a much higher interest rate than they’ll actually pay. Meanwhile, borrowers who take out fixed-rate insured mortgages of five years or longer have their income tested against the interest rate that they will actually be paying. The end result is that borrowers can now typically qualify for much larger mortgages if they opt for a longer-term, fixed rate mortgage.

The stress test also requires that home buyers won’t be spending more than 39% of income on such housing-related expenses as mortgage payments, heat and taxes. In addition, total debt service (TDS) mustn’t be more than 44%. TDS is the percentage of the borrower’s income that is needed to cover housing costs plus any other monthly obligations, such as credit card and car payments.

Low-Ratio Mortgages

In addition, new restrictions are being imposed on when Ottawa will insure low-ratio mortgages. These measures are aimed at portfolio insurance, a type of bulk insurance that banks use for mortgages with down payments of 20% or more. Starting November 30, the federal government will require portfolio-insured mortgages to qualify under the same criteria used for the insurance taken out on homeowners with small down payments.

The new rules will be based on the following criteria:

• Amortization is 25 years or less,
• The purchase price is less than $1 million,
• The buyer’s credit score is at least 600, and
• The property will be owner-occupied.

So, under the new stress test, if you were to buy an $800,000 home, you’d need to make a down payment of 5% on the first $500,000 ($25,000) and 10% on the remaining $300,000 ($30,000) for a total of $55,000 or 6.9% of the total purchase price, according to mortgage website Ratehub.ca. Previously, you would’ve only had to put down $40,000.

The new stress tests apply only to new mortgages, not renewals. However, the effect is likely to be significant as a majority of homeowners are thought to take out the types of fixed-rate mortgages that will be affected by the stricter qualification requirements.

While Finance Minister Bill Morneau said the stricter “stress test” will likely have the greatest impact on expensive housing markets such as Toronto and Vancouver, he acknowledged it will also affect home buyers in softer markets. “We’re trying to manage the risk for all Canadians,” he said, adding: “We worry about someone in Halifax or Ottawa or Saskatoon as much as we worry about someone in Toronto or Vancouver.”

Mr. Morneau said he expected the changes would have a “modest” and gradual effect on the Canadian housing market. “It’s hard to state with certainty what the outcome will be,” he said. “For some buyers they might defer their purchase for a little while; for other buyers they might decide to buy a slightly less expensive home.”

How Much Can Lenders Handle?

The Finance Minister also said that the government will release a consultation paper in the coming weeks, to solicit views from mortgage lenders about how they can take on more risk in the market. Because many mortgages are guaranteed by Canada Mortgage and Housing Corporation (CMHC), Mr. Morneau said that too much of the responsibility is currently placed on the government and taxpayers.

Bottom Line: If you’re considering buying a home, consult with your advisors, who can help ensure that your monthly mortgage payments fit neatly within your finances and your financial plans.