Last week, the Canadian Finance Minister announced mortgage changes that will affect millions of house hunters across Canada. Beginning this October 17th, large regulatory changes will begin that will attempt to stabilize targeted portions of the Canadian housing market. Specifically, these changes will reduce mortgage eligibility for many Canadians, close some taxation loopholes for foreign buyer and gradually, make banks for responsible for their lending behaviour.
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But First The Basics on CMHC
Before we jump into the detail, it’s important to understand the basics of how Canadian Mortgage and Housing Corporation (CMHC) works. Generally, this government organization protects the general economy from mortgage defaults. CMHC will cover the financial costs when a mortgage holder defaults on their payments.
CMHC is mainly funded by borrowers that are required to pay insurance fees when they acquire an insured mortgage. Insurance fees range from 0.6% to 3.85% and is required for all Canadians that have a down payment that is under 20%. For example, a borrower with a 5% down payment on a $500,000 mortgage would have to pay $19,500 in CMHC insurance.
Interestingly, CMHC was created to motivate post-WW2 financial institutions to issue more mortgages and in connection, stimulate the Canadian economy. Since then, it has achieved this and now many warn that CMHC insurance may be helping to create a housing bubble.
On to the recent housing changes!
Mortgage Changes # 1 – Reduce Mortgage Availability to Many Canadians
The biggest impact to Canadians is the new “stress test”. This new policy requires that all insured borrowers must qualify for a theoretical mortgage at a higher rate than what the banks typically offer. This means that insured borrowers will qualify for a lower mortgage amount than they would have in the past.
This new qualifying rate is the Bank of Canada’s 5-year fixed rate, which is currently 4.64%. This rate is the average posted rate of the six main Canadian banks. Previously, banks only needed to qualify borrowers at a higher rate for select mortgages, but now all mortgages must be approved at the Bank of Canada rate.
Ultimately, this translates into a reduced insured mortgage amount that Canadians will qualify for.
Mortgage Changes # 2 – Making Banks For Liable for Their Behaviour
Another big change is the gradual increase of lender liability. Currently, lenders are not responsible for costs that are associated with defaulting mortgages. Many academics criticize the current system because the lenders have little incentive to be cautious as there are low costs when a borrower defaults, but high rewards when they don’t.
The new proposed regulation would change this. Now, lenders would be responsible for a portion of any defaulted mortgage. This would hopefully cause lenders to be more cautious about whom they lend to. However, there is also a high possibility that lenders will increase their mortgage rates to cover the increased cost of covering defaulted mortgages.
Mortgage Changes # 3 – Changing Foreign Buyer Loopholes
Another big move by the Federal government is to close some loopholes that allowed foreign buyers to evade taxes on sold properties. The foreign buyers were falsely claiming that the properties were their primary residence and therefore, not paying capital gains tax on the increased property value.
How this will affect the housing market is very debatable. The proportion of foreign buyers is unknown to the government and therefore, the reduction of foreign demand is equally questionable.
The Overall Impact
Overall, these changes will likely have a big impact of Canadian mortgage borrowers. The exact impact is debateable, but none-the-less it will limit the participation of many borrowers.
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