Real Estate

Mortgage stress test: the new rules of engagement

By Staff

The Office of the Superintendent of Financial Institutions (OFSI), which regulates banks and mortgage insurance companies, released further mortgage rules which will come into effect on Jan. 1, 2018, Toronto real estate and licensing lawyer Anar Dewshi writes in The Lawyers Daily.

The purpose of this guideline is to ensure that federally regulated lenders adopt a rigorous approach to both mortgage underwriting and their internal risk protocols, says Dewshi, principal of Dewshi Law Practice.

“The most important rule change is the expansion of the mortgage stress to all potential homebuyers,” she says. “Previously, the stress test was only required for insured mortgages. This means that homebuyers who don’t require mortgage insurance because they have a down payment of 20 per cent will now have to undergo the mortgage stress test. The OFSI realized that the source of funds for the deposit didn’t necessarily come from the homebuyers but from gifts from family and friends.”

The mortgage stress test applies the typically higher Bank of Canada posted rate when calculating a borrower’s gross debt service and total debt service ratios to evaluate the homebuyer’s ability to repay the loan in a higher interest rate environment or with a reduction in household income, Dewshi says.

“The gross debt service is the carrying costs of the home, including the mortgage payment and taxes and heating costs, relative to the homebuyer’s income,” she writes. “The total debt service is the carrying costs of the home and all other debt payments relative to the homebuyer’s income.”

Dewshi says the new mortgage rules will have an impact on first-time homebuyers and those with increased household debt.

“The new rules will make it harder for them to obtain mortgage funds because they will likely not be able to pass the mortgage stress test,” she writes. “This will make high-priced homes unattainable but as a result, they will be prevented from taking on a mortgage that they cannot afford, which is ultimately the objective behind new federal mortgage rules.”

Potential homebuyers who are unable to purchase their home through federally regulated lenders may turn to private, unregulated lenders, Dewshi explains.

“A mortgage is considered to be a 'private' mortgage if the lender is not a Schedule I or II bank, registered loan or trust company, a licensed insurer, or a subsidiary of any of them; pension fund; or any other entity that lends money in the ordinary course of its business. Funds are usually advanced from an individual, a corporate client or group of clients, rather than funds advanced by a financial institution,” she writes.

Dewshi points out that private mortgage lenders are unregulated, are not mandated to carry mortgage insurance, and often charge an interest rate of seven to 10 per cent, at least double the rate of traditional lenders.

“Although private mortgages are a means to an end for potential homebuyers, they bring with it increased risk to financial stability and increased debt load,” she writes. “Real estate lawyers should be aware of the specific professional responsibility rules related to private mortgage transactions in Bylaw 9, Financial Transactions and Records.

"Increased reporting is required by lawyers, namely, Form 9D, Investment Authority and Form 9E, Report on the Investment. Lawyers must not represent both the lender and the borrower in a private real estate transaction due to conflict of interest concerns.”

Lawyers should advise borrowers on the risks associated with private mortgages, namely the high interest rate to household debt and failure to maintain payments, which may lead to power of sale or foreclosure, Dewshi says.

“The changes will have an impact on the key real estate markets, such as Vancouver and Toronto, since potential homeowners with less mortgage funds will further cool this extremely hot housing market,” she writes.

“This will lead to the decrease in purchase price and increase overall affordability for buyers since the value of homes is based on the affordability of the buyers. The rules will also have an impact on homeowners who wish to refinance or sell their house because they will lose the equity in their home from the lack of demand from buyers.”

Although alternatives are available to potential purchasers, Dewshi suggests buyers either look for a less expensive home or wait until a larger down payment can be accumulated.

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