Changes to the Canadian Mortgage Rules and Implications in Vancouver
By Orla O’Malley
On October 3rd, 2016, Ottawa unveiled key initiatives aimed to address risk in the Canadian housing market and protect Canadians from “taking on too much debt”. These initiatives will ultimately slow the Canadian housing market both by potentially discouraging foreign home purchases by closing a tax loophole and by making it more challenging for Canadians to get mortgages.
The federal government implemented these initiatives through four changes, and this article discusses the two most pertinent: the “Stress Test” and the closure of a tax loophole.
1. More Rigorous “Stress Test”
One of the most discussed of the changes, is the “Mortgage Rate Stress Test” which, effective October 17th, 2016, will apply to all insured mortgages. The “Stress Test” is a measure in mortgage qualification, where consumers are qualified at the Bank of Canada Benchmark rather than current contract rates. The Bank of Canada’s posted rate is typically higher than the contract mortgage rate most buyers pay. For example, as of this blog post’s date the Bank of Canada posted rate was 4.64%, compared to roughly 2% or so on variable rate mortgages. Before these new rules, the requirement only applied to a subset of insured mortgages with variable interest rates (or fixed interest rates with terms less than five years).
This more strenuous qualification is designed to protect consumers against possible rate increases that may come at some point in the future.
This change may reduce the number of buyers in the Canadian housing market. For example, many first time buyers relied on the five year fixed rate mortgage products to allow them to qualify for loans and get into the competitive housing market. To illustrate this point: before these rules, a first time buyer making a salary of $80,000 per year, with $0 in debt and a 5% down payment, would qualify for a purchase price of up to $450,000. Under these new rules, that same consumer can only qualify for a property worth about $360,000. That amount won’t go very far in Vancouver’s competitive housing market.
The Stress Test will also require that the buyer spend no more than 39% of income on home-carrying costs like mortgage payments, heat and taxes. Further, it will require that the buyer spend no more than 44% of income on those costs when including all other debt payments.
As for timelines, these changes apply to new mortgage insurance applications and approvals received after the effective date (October 17th), or when after that date the homeowner enters a contract of purchase and sale for the property against which the loan is to be secured. Applications received by October 17, 2016 must be funded by March 1, 2017 to be exempt from the new qualification rules.
2. Tax Loophole Will Be Closed
A hot topic in Vancouver real estate has been the increased competition in the market place from foreign markets. The new rules discourage property purchases by foreign home buyers by closing a tax loophole some of them relied on.
The Canadian income tax system allows a significant income tax benefit to homeowners selling their “principal residence”, in the form of an exemption from capital gains taxation. The income tax exemption applies at the time of sale of the property and it relies on a formula contained in the Act that requires computation of the eligible amount of the gain that is prorated for the number of years that the property was designated as the person’s principal residence.
However, under the new rules, a person who was a non-resident of Canada when they purchased a property will no longer be able to benefit from the exemption for the years they were a non-resident. This applies to dispositions after October 3, 2016.