As the federal election approaches this fall, many people are discussing the last four years. We’ve seen our fair share of changes in that time, and the housing market is no exception. Housing affordability is a major concern for many Canadians – and rightfully so. The facts speak for themselves: in 1980, the average home price in Canada was about five times the average income; today, it’s about 10 times as much.
The high cost of real estate makes it tough to afford a home in pricey markets like Toronto and Vancouver. So, has the housing market gotten any better over the last four years? Let’s take a look at the two major changes to the housing market during this time to see if homebuyers have benefited.
The Mortgage Stress Test
The mortgage stress test is the most well-known change in the housing market, and it’s been a popular topic of discussion at dinner parties and barbecues. You may have heard of the stress test, but do you really understand what it means?
The federal government introduced the stress test in two stages between 2016 and 2018. In a nutshell, the stress test made it more difficult to qualify for a mortgage when applying with a federally regulated lender. The goal was to limit the amount of money homebuyers could borrow; they did this by making borrowers qualify at a rate that was higher than the actual mortgage rate offered by banks. This lowered the amount borrowers could qualify to buy a home, and it forced them to adjust their home-buying expectations. For example, some homebuyers are choosing to buy less-expensive homes, while others are buying more-affordable options – like townhouses or condos – instead of houses. Some homebuyers have even decided to postpone their plans to purchase a home altogether.
The stress test was implemented in two stages. The first stage came into force in October 2016 with a limited scope. This version of the stress test targeted buyers who put down less than 20% on a home. These homebuyers already have to buy mortgage default insurance, so this change further reduced the amount of money that they could borrow for their mortgages. The goal of the stress test is to ensure that you would be able to afford higher payments if your mortgage were renewed. At this stage, you have to qualify at your mortgage rate or at the Bank of Canada’s benchmark interest rate (currently at 5.19%), whichever is higher.
In January 2018, the second stage of the stress test went into effect for those making a down payment of 20% or more. Under this stress test, borrowers need to demonstrate that they can afford the Bank of Canada’s benchmark interest rate or their mortgage rate plus 2% – whichever is higher.
Although there’s no denying that the stress test has made it more difficult to qualify for mortgage – especially in cities like Toronto and Vancouver, where home prices are the highest in the country – one could argue that it has also helped homebuyers. The appreciation of home prices has slowed considerably since the stress test was introduced; we’re no longer seeing double-digit home price appreciation in the aforementioned housing markets. And, although home prices haven’t come down 20-25% as some had predicted, the slower appreciation has given homebuyers a chance to save money as they try to keep up with these costly housing markets.
If the federal government was hoping to slow home prices with the stress test, it has succeeded. The stress test, combined with changes at the provincial level, have helped slow home prices for the time being. Hopefully, first-time homebuyers now have a chance to get into the real estate market.
Although it remains to be seen whether this is just a brief pause before home prices keep going up, homebuyers have also started to get more creative in qualifying for mortgages. For example, parents continue to gift down-payment money to their children or co-sign on mortgage loans. And, others opt to buy a home with someone else as a co-applicant. Considering at least one of these alternatives can help counteract the effects of the mortgage stress test.
Shared Equity Mortgages
However, the federal government wasn’t finished when it introduced the stress test. More recently, it announced the First-Time Home Buyer Incentive (also known as shared-equity mortgages). The government touted it as the ideal program to help those struggling to enter the housing market. But, does it really help that much? Let’s take a closer look.
Set to launch on September 2, 2019, the incentive allows homebuyers to secure smaller mortgages with more affordable monthly payments; this is accomplished through down-payment funding from the government. Depending on whether you’re buying an existing or new home, you may be eligible for a top-up of 5% or 10% on your down-payment funds.
The top-up is the equivalent of an interest-free loan. Although it’s considered a second mortgage, you won’t be required to pay any interest or make any payments as long as you buy and hold onto your home. However, you do have the option of repaying the loan at any time and, unlike a closed mortgage, you won’t incur a costly prepayment penalty. You’ll have to repay the loan eventually, but not until you sell your home or you’ve held onto it for 25 years, whichever happens first.
You may be wondering how the federal government makes money on this scheme. There is a catch: the amount you have to repay to the federal government isn’t simply the original amount you borrowed from the First-Time Home Buyer Incentive. It’s based on the value of your home at that time. For example, say you buy an existing home for $400,000 with a 5% top-up from the government – or $20,000. Then, say you sell your home in 10 years for $500,000. Because your home’s value has gone up 25% in a decade, you’ll be required to repay $25,000 ($20,000 times 1.25) – a 25% increase. However, the government doesn’t just share in the upside; it also shares in the downside. If home prices went down, the government would share in your loss, too, and your repayment could be less.
To be eligible for the First-Time Home Buyer Incentive:
- Your annual household income must be equal to or less than $120,000.
- Your mortgage amount must be limited to four times your income plus the incentive amount.
This means that the most you could afford to spend on a home you purchased with the incentive would be around $500,000, depending on how much you’re putting down.
The jury is still out on how much the First-Time Home Buyer Incentive will help those looking to get into the real estate market. You’ll be hard-pressed to find a decent property in the Greater Toronto Area or Greater Vancouver Area for less than $500,000, although condos may be an option. Otherwise, you may be forced to “drive until you qualify” and buy a home in a community with more affordable home prices. The incentive could really help in less-expensive markets like Winnipeg and Ottawa; but, for Toronto and Vancouver, it remains to be seen whether this change will help many homebuyers at all.
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.
This is a guest post by Sean Cooper, the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedIn, Twitter, Facebook and Instagram.