Mortgage Mayhem

Millennials are frequently blamed for the downfall of businesses and even entire industries. These include department stores, cereal, and diamonds just to name a few. Heck, some believe we will be the downfall of society as a whole. The accusations sound exaggerated and even humorous but the reality is; we’re not spending money on a lot of the things that our parents spent money on.

I’d like to think the reason is that the world is a lot more financially hostile than it was 30 years ago. Think of it this way; back then, someone working a blue collar job in a factory could earn enough to support a family and buy a home. There’s no way that’s happening now.

And recent developments aren’t helping. The Office of the Superintendent of Financial Institutions (OSFI) is the Canadian regulator for banks, and on October 17, 2017, they updated one of their guidelines. Guideline B-20 − Residential Mortgage Underwriting Practices and Procedures outlines the procedures and practices each bank should follow in order to approve and extend residential mortgages to the general public – people like you and me.

The major change involves increased stringency in stress testing. For each mortgage application, as part of their risk approval process must run a stress test involving different scenarios to assess whether the borrower can repay their mortgage under various circumstances. One of these is the increase in interest rate. Interest is a percentage of the total value of your mortgage and is repaid along with the principal borrowed amount. As interest rates rise, the value of each payment made at every interval increases.

The change in the guideline requires uninsured mortgage borrowers to show that they can afford to pay for a mortgage at a rate that is 2% higher than the rate that they are applying for in order to get approval. These borrowers are those that have made a 20% downpayment and are not required to get mortgage insurance with the Canadian Mortgage and Housing Corporation (CMHC).  This translates to a substantial decrease in borrowing power.

To illustrate, let’s assume that you have enough income to spend $2,000 of your monthly income on mortgage payments. The rate that you are applying for is a 25-year term with a 2.45% fixed interest rate. Based on these numbers, theoretically the maximum mortgage you could obtain is around $440,000. With the new rules, you have to add a stress test of 2% to the 2.45% that you are applying for. If you apply the same formula at 4.45%, the maximum mortgage you could obtain drops to around $350,000. This gap widens as the value of your loan increases. If you could originally afford a $1,100,000 mortgage, you would only get a $900,000 mortgage.

The reason for this change was mainly to protect the housing market from shock in case of additional interest rate hikes. Nevertheless, the change adds further financial pressures on millennials and any new families looking to buy a home. With finances tight and the future uncertain, it’s even more important to know what financial resources you have and how to use them.

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