New Mortgage Distribution Data From The BoC Shows Stress Testing Is A Huge Deal

New Mortgage Distribution Data From The BoC Shows Stress Testing Is A Huge Deal

Canadian real estate is going to have mortgage capital throttled, and it may have a serious impact on capital flows. Numbers sent to us from the Bank of Canada (BoC) give us one of the most comprehensive looks at mortgage borrowing behaviour. Borrowing the absolute maximum, is one of the most popular strategies homebuyers in Canada use. This means new mortgage stress testing is going to have a huge impact on the way buyers shop for homes.

A Quick Refresher On Mortgage Stress Testing

Stress testing ensures that buyers can continue to pay their mortgages, even if their interest rate continues to rise. Lenders do this by testing your ability to pay your contract rate, if it was at least 200 bps (a.k.a. 2 percentage points) higher, or the BoC rate – whichever is greater. High-ratio borrowers, who put between 5% up to 20% down, were subject to these rules starting October 17, 2016. Starting this year, low-ratio borrowers, those that leave more than 20% as down payment, now get a stress test as well. Stress testing is a simple process, but will have huge consequences on the Canadian real estate market.

If you already know what stress testing is, feel free to skip this paragraph. For those that don’t know, we’ll run through a quick example. Let’s say you made $100,000 per year, and you found a great 5 year fixed rate of 2.84%. Under normal borrowing circumstances, you would be able to borrow ~$675,000 for a home. Under a stress test, the lender would calculate your maximum borrowing room at 4.99% today. This would reduce the maximum you can borrow to $522,000 – a reduction of 22.66%. Over that past few months we’ve heard lenders and agents say the new stress tests won’t be an issue because most people don’t borrow the maximum. However, those lenders and agents didn’t have access to the BoC’s data to analyze the whole mortgage market. Now that we have access, we can see people do borrow the maximum, so it likely will be an issue.

Over 22% of High-Ratio Borrowers Leave The Minimum Downpayment

Now we know high-ratio mortgage borrowers typically do borrow the absolute maximum they can borrow. In 2014, the BoC found that 22.27% of borrowers, were high-ratio borrowers that had a loan-to-value (LTV) ratio of 95%. This means they put the least amount of money (5%) they could possibly put down, in order to buy a home. The second most popular downpayment for this segment of borrower was a 90% LTV ratio, meaning the borrower put 10% down. However, only 5.85% of borrowers did that in 2014. This trend tapered in 2016, once the mortgage stress tests were live.

Source: Regulatory filings of Canadian banks and Bank of Canada calculations. Better Dwelling.

Despite only two months of stress testing in 2016, the reduction of these borrowers was significant. Borrowers with an LTV ratio of 95%, dropped to 18.04%, a 19% decline from 2014. Borrowers with an LTV ratio of 90%, dropped to 5.22%, a 10% reduction from 2014. The BoC estimates the new rules led to a $21 billion dollar reduction in buying activity. The good news is many of these buyers may have put more down, and got a low-ratio mortgage.

23% of Low-Ratio Borrowers Leave The Minimum Downpayment

Low-ratio mortgages, those with 20% or more as a downpayment, increased significantly during this period. Despite higher down payments, these borrowers still prefered to max out their borrowing room. In 2014, 20.05% of mortgages in the data set had a LTV ratio of 80%, meaning they put exactly 20% down. By 2016, borrowers with LTV ratios of 80% saw a rise to  23% of borrows. Starting in 2017, these mortgages will now be stress tested in a similar method to high-ratio mortgages. BoC estimates this will lead to a reduction of $15 billion in mortgage lending activity.

More than 40% of mortgage borrowers pushed their personal limits to buy a home. The impact of stress tests might be much more significant than previously anticipated. Liquidity is going to be drastically reduced on the higher end of buying power, which will drag the median purchase price lower. Good news if you have a lower priced property, as there will likely be more competition. Bad news if you have a higher priced property, since your qualified buyer pool just shrunk… by quite a bit.

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  • Michael 6 years ago

    Local governments pay their tax bills with real estate transfer taxes. They’re going to be begging for stress tests to be loosened by the end of the year.

  • Trader Jim 6 years ago

    Doesn’t help that MSM is running pieces with mortgage brokers pretending the exemption rules are a “loophole.” Similar exemption rules existed before, and they are also reduced by over 20% as well. It’s a nice pump from the real estate industry.

    Great job with these numbers by the way. It actually highlights how nutty Canadians are for homeownership.

    Little advice for those that actually want to retire: Put as much down as you can possibly pay. You know how you think leverage is making you more money? Leverage is also making you pay more interest than you probably understand. That’s the part your agent/broker will leave out usually.

    • Johnny 6 years ago

      Not sure if all these apply if you brought the property as an investment. You want to pay as little as possible and borrow as much as possible.
      I know people who have 5+ properties, all rented out and making positive cashflow even with the rate increases.

      Yes, Canadians are nuts for real estate, but they are also making more money with the increase of immigrants.

      • Tommy 6 years ago

        Putting a minimum down might work in small towns and cities outside of Toronto and Vancouver. In those two major cities, one often has to put down over 30% in order to make positive cash flow.

  • Jackie 6 years ago

    “More than 40% of mortgage borrowers pushed their personal limits to buy a home.” Any idea if these are concentrated in Toronto and Vancouver areas?

    • Tommy 6 years ago

      Good question, Jackie.

    • Better Dwelling 6 years ago

      Regions with high home price growth (Toronto and Vancouver) accounted for 24% of high-ratio mortgages, and 50% of all low-ratio mortgages. Loans in these regions represented 46% of all mortgages with LTVs of 80%. We’ll break those numbers down a little better in the not so distant future.

  • Leo S 6 years ago

    Doesn’t add up. The BoC is estimating a $15B impact from new rules vs $21B from old rules. That means they expect the impact to be less, not more significant as you are concluding.

    Also you are equating borrowers who put down the minimum (in high ratio or low ratio) as equal to borrowers that “max out their borrowing room”. That is not true. The data does not show what they were approved for vs what they actually borrowed. Just because someone chooses to put the minimum down (because they can earn more elsewhere) doesn’t mean they are maxing their borrowing.

  • Al Daimee 6 years ago

    There is a key fact missing when comparing 2014 high ratio mortgages to 2016 and 2017 numbers. CMHC increased insurance premiums for high ratio mortgages, which erodes the downpayment and encourages larger (ie. 20%) downpayments to avoid throwing your hard-earned money away on the insurance premium.

    CMHC Premiums in 2014:
    95% LTV (5% down) @ 3.15%
    90% LTV (10% down) @ 2.4%

    June 1st, 2015 New CMHC Premiums:
    95% LTV (5% down) @ 3.6%
    90% LTV (10% down) @ 2.4%
    (this encouraged more people to get to 10% downpayment)

    March 17th, 2017 New CMHC Premiums:
    95% LTV (5% down) @ 4%
    90% LTV (10% down) @ 3.1%
    (WHY would you put 5% downpayment only to pay a 4% insurance premium???)

    Oh yeah, one more thing. This insurance premium is subject to provincial sales tax, payable up front) in Manitoba, Ontario and Quebec. Taking a $500,000 home let’s do the math on a 5% down LTV:

    95% LTV = $475,000 mortgage
    4% CMHC insurance = $19,000
    Ontario PST payable up front = $1,520 (just about the same cost as your legal fees for the purchase)
    Total cost of buying that $500K property is now $520,520 with 5% down.

    The rationale of getting 20% down on a property via family help/loans is something we Realtors have seen frequently, because the insurance premium is far too hefty. I tell our buyers that making the bare minimum downpayment just doesn’t make any sense financially and I believe this is a common notion, hence the significant decline since 2014. The stress test helped propel the trend last year, but the mortgage insurance premium increases were really the trigger for where that trend began.

    Unfortunately, not everyone has the help available and so they have to bite the bullet and pay the premium if they want to get their foot in the market. In this situation, the best they can do is hammer down the mortgage as much as possible while interest rates are low, so that they can handle a higher interest rate down the road when it comes time for the mortgage renewal.

    The talk amongst the industry is “What will happen to the real estate market in 2018?”. It will likely be 2 quarters before any real conclusions can be made as to how much the new stress test actually affects those 20% downpayment buyers. I think it will compress many Toronto buyers into the already heated $600K-$850K range and those who were comfortable with a $1MM mortgage previously will be able to easily compete in the sub-$850K market. The human factor that nobody can’t account for is whether or not buyer expectations can be downgraded to match with the approved budget. Only time will tell us that.

    • Oliver Clozof 6 years ago

      Sellers expectations need to decrease.

  • Andreas Raujoan 6 years ago

    Let’s hope this is the straw the breaks the camel’s back and finally brings the Canadian housing bubble crashing down. While I’m skeptical, it is justifiable to be cautiously optimistic that this might gut sentiment and finally begin the long road down to normalization. I’m still hoping for an all-out crash (cue angry, clueless realtors foaming at the mouth), but if at least we have a serious correction it would be a blessing.

  • Brian 6 years ago

    Mortgage eligibility and affordability will limit price increases and probably not cause prices to decline much if at all.

  • Skeptical 6 years ago

    Mortgage eligibility and affordability will limit price increases and probably not cause prices to decline much if at all.

    • Andreas Raujoan 6 years ago

      Spoken like a dirty realtor. Also, nice snafu there posting your pro-bubble drivel twice under two different names. #fail

    • Burnabonian 6 years ago

      You forgot to start that with “I desperately hope that”

  • question guy 6 years ago

    just because ppl put down 5% doesn’t mean they maxed mortgage borrowing… that’s not a fair conclusion.

    If I want a property for 105, and have 50 cash, I might choose to use 5 to acquire it rather than all my $$$

    just saying…

    • Trader Jim 6 years ago

      If you had $50k cash, and only put 5% down you had a) prior financial obligations, or b) are willing to take a leveraged loss on the cost of interest (you’re dumb).

      In the current market in most of Canada, a tenanted property purchased over the past 3 years would have negative carry. If you’re subsidizing your losses for a potential gain on value, you’re playing a ponzi, not investing. People that understand the CO of not using their maximum downpayment to make higher yield investments, would know that real estate doesn’t make sense as a financial investment.

      There’s a reason developers aren’t making rentals, they’re flipping pieces of crap for idiots to carry the risk. If they actually thought the land of value would continue to go up, or yield made sense, they would become landlords. Pensions are unloading rentals for this purpose right now. If you think individual condo buyers, struggling with 5% down payments, are smarter than pensions, there’s no helping you.

      • Leo S 6 years ago

        > If you had $50k cash, and only put 5% down you had a) prior financial obligations, or b) are willing to take a leveraged loss on the cost of interest (you’re dumb).

        Nope. If you’re going to buy, it is smart to put the minimum down. You can make more by investing your money rather than sticking it in the house. Even less than 20% down can sometimes be smart depending on the return on your investments.

  • sowhen 6 years ago

    Interesting for sure.

    In addition the ways around this are to take a small mortgage and get the balance as a HELOC… PLUS the 30 year mortgage is making a resurgence I hear!

  • Canadian Mortgage Growth Falls To The Lowest Rate In 2 Years | Better Dwelling 6 years ago

    […] that. If we combine these factors, we’re looking at a sizable impact, especially when you consider how many homebuyers max out the amount they can borrow for a home. So, mortgage credit is decelerating, interest rates are rising, and the government wants you to […]

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