How the Federal Governments new mortgage rules affect Canadian homebuyers

By Vicent Naidoo

“With Canada’s much envied stable financial system and its impressive ability to have survived the 2008 world financial crisis, the Canadian government now sees it housing sector as a prime candidate to implode as Canadians increasingly take on bigger mortgages in an era of historically low-interest rates. It is perhaps prudent to contrast the new against the old rules, to understand the new ones better.”

“Widespread reported abuse of this so–call tax loophole by foreign real estate speculators who have failed to pay capital gains tax on the sale of a Canadian property are mainly a reason for the new rules.”

In October 2016, Canada’s Liberal government announced some fairly dramatic reforms in rules relating to the Canadian housing market. Ostensibly, the changes were a response to some issues; a runaway out of control price rise in some cities: the growing unaffordability of housing in places such as Vancouver and Toronto, and the concerns relating to foreign buyers who buy and flip Canadian homes for profit- without paying capital gains taxes. The Federal government has now erected some cornerstones in the form of new rules, hoping it will cool down a market that many say is a bubble waiting to burst. With Canada’s much envied stable financial system and its impressive ability to have survived the 2008 world financial crisis, the Canadian government now sees its housing sector as a prime candidate to implode as Canadians increasingly take on bigger mortgages in an era of historically low-interest rates. To understand the new rules, it is perhaps prudent to contrast them with the old rules.

New “Stress Tests” and Down Payments requirements.

Before the new rules, homebuyers with a down payment of at least 5 percent of the purchase price, but less than 20 percent were compulsorily backed by Canada Mortgage and Housing Corp. Insurance (CMHC) mortgage insurance that protected the lender if the home buyer defaults. These loans were known as “high loan-to-value” or “high ratio” mortgages. In situations in which the buyer has 20 percent or more for a down payment, the lender or borrower could obtain “low-ratio” insurance that covers 100 per cent of the loan in the event of a default. New federal changes from the Canadian government from October 17, 2016, now mean homebuyers with less than a 20% down payment which are applying for a high-ration mortgage will have to undergo a so-called “Stress Test.” This Stress Test would be applied by the lender to see if the home buyer could still afford the mortgage if interest rates were to rise. The home buyer would need to qualify for a loan at the negotiated rate in the mortgage contract, but also at the Bank of Canada’s five-year fixed posted mortgage rate, which is an average of the posted rates of the big six banks in Canada. This rate is usually higher than what buyers can negotiate.

Other aspects of the stress test require that the home buyer will be spending no more than 39 percent of income on home carrying costs like mortgage payments, heat, and taxes. Another measure called total debt service includes all other debt payments and the TDS ratio must not exceed 44 per cent of household budgets.

Insurance for low ratio mortgages and shorter Amortization periods

As many properties in cities such as Vancouver and Toronto are worth more than $1 million, another change the government has imposed is new restrictions on when it will provide insurance for low-ratio mortgages. Also, mortgage period have progressively been shortened. In the past, as people struggled to cash in on the housing boom, there were mortgages of thirty-five, forty years or even longer; this is now not the norm. The new rules restrict insurance for these types of mortgages based on new criteria, including that the amortization period must be a much more regular 25 years or less, the purchase price is less than $1-million; the buyer has a credit score of 600, and the property will be owner-occupied.

New reporting rules for the primary residence capital gains exemption

Under the old rules, any financial gain from selling your primary residence is tax-free and does not have to be reported as income. As of this tax year, the capital gains tax is still waived, but the sale of the primary residence must be reported at tax time to the Canada Revenue Agency. Widespread reported abuse of this so–call tax loophole by foreign real estate speculators who have failed to pay capital gains tax on the sale of a Canadian property are mainly a reason for the new rules. The new change is primarily aimed it seems at preventing foreign off-shore buyers who buy and sell homes from claiming a primary residence tax exemption for which they are not entitled. Now, all taxpayers will have to declare on their income tax returns a sale of a property that they claim is their primary residence. To qualify for this, the homeowner or a family member must have lived in the home at some time during the year. The Department of Finance said the change would ensure that the principal residence exemption is used only by Canadians, who will designate just one property as their principal residence in a given year.