How to Plan for Homeownership During Difficult Times

Guest post by Pauline Tonkin

The landscape for Canadian homeowners and buyers has shifted over the past few years. More Canadians than ever are motivated to become first time buyers, in part due to the rising costs of rent suitable homes. However, rising property values and new stress test conditions imposed by the federal government for mortgage financing have made it more difficult to enter the real estate market.

What Is a Stress Test and How Does It Impact Financing Options?

In response to the ever-increasing debt loads of Canadians, in the fall of 2016 the federal Government introduced a mortgage stress test for all mortgage applicants. A stress test is intended to help buyers avoid taking a mortgage that offers a low interest rate but with a payment that’s more than they can afford. Regardless of down payment amount, credit history, income, and other factors, this was a significant change in financing rules for all home buyers.

In practice, the result of the stress test was a 10% - 20% reduction in buying power, limiting a buyer to shop for a home in a lower price range. Then when rates do go up, the stress test helps the buyer afford high mortgage payments, even though they are making mortgage payments based on a very low interest rate today.

How to Protect Yourself from Rising Interest Rates

As part of the application process, lenders must use the greater of the benchmark posted rate or the contract rate plus 2% to qualify someone for financing.

• The benchmark posted rate is set by the government.
• The contract rates are based on the market and set by the lenders.

For example, if the benchmark posted interest rate is currently 5.25% and the contract rate the lender is offering is 2.29%, the lender must use the benchmark rate to qualify the applicant because 5.25% is higher than the contract calculation (2.29% + 2% = 4.29%). Because rates have shifted upwards in 2023, the contract rate plus 2% applies, not the benchmark rate.

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Understanding the Changes that Affect Home Buyers and Sellers

In addition to the mortgage financing changes, the real estate market across Canada has experienced further adjustments. Major cities such as Toronto and Vancouver assigned the Non-Resident’s Property Tax while Alberta still struggles due to challenges in the oil and gas industry. Even with these constraints, the markets have been active with many buyers competing for a declining inventory of properties.

The pressure on interest rates to trend down during COVID-19 helped generate a softer landing for real estate prices in many cities. It created a balanced market for motivated buyers with stable prices, low interest rates, and fewer people viewing homes; the result for qualified buyers was opportunities to buy sooner than later.

Although sales of homes fell from the previous year, prices didn’t change much and people still wanted to buy and sell. The initial forecast for the market for the second half of 2020 varied by source of information. However, as we look back at 2020, the demand for housing was very strong and prices in key areas rose at a frantic pace.

What Happened in 2021

While rates remained low throughout 2020, in February 2021 a shift in the bond market pushed lenders to raise the 5-year fixed rate back over the 2% mark. This change forced some buyers to reconsider what they could afford to spend on a home, but the big shift on this front came on June 1st when the government increased the rate for the stress test rate from 4.79% to 5.25%.

An increase in qualifying rates of such a significant amount reduced everyone’s buying power by 4% ($4,000 for every $100,000). The government made this change to help reduce the pace of pricing increases. Although this will impact buyers who require a mortgage, time will tell if it makes a shift in prices for those who bought homes with cash.

Measures During the COVID-19 Pandemic

During the pandemic, lenders and insurers (CMHC, Genworth, and Canada Guaranty) created a unified policy to address temporary loss of income for home buyers in the market, those who needed to refinance their existing mortgage, or those who needed to defer payments for up to 6 months. Lenders continue to offer creative financing to home buyers and homeowners as a result of lasting changes in the real estate industry due to COVID-19.

What Can You Expect In the Future?

In 2022, the Bank of Canada made significant increases to the overnight lending rate, which in turn, prompted lenders to increase their Prime Rate. This impacted variable rate mortgages and home equity lines of credit.  As for interest rates for fixed rate mortgages, pressures on bond yields increased those rates later in 2022 and during the first half of 2023. While lenders continue to maintain prudent measures in underwriting mortgage applications and are even stricter on credit history and borrowing behaviour, those who take the time to manage their finances wisely are still very much in a position to buy.

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Create a Financial Plan for Homeownership and Beyond

For individuals and families, this is the time to create a short term financial plan to rebuild after the pandemic, and a longer-term plan to create a stronger financial future. Working with your trusted professionals, including a financial planner, accountant, lawyer, and independent mortgage planner, now is the best time to review your current situation. Establish a roadmap for your home ownership, financing, and investments, as well as your estate and legacy planning.

Pauline Tonkin is a licensed independent mortgage advisor, known for helping her clients make informed decisions about their mortgage and borrowing options. She is committed to exceptional client service and an unwavering standard of care and respect.

Article was updated July 2023.