How does the mortgage stress test affect first time buyers?

I am working with a first time buyer right now, and I admit, I was a little startled when she told me that if she proceeded with a condo offer on the modest condo we were looking at (600 sq ft), it would cost her $ 2300/month, including taxes and condo fees. And that was with a hefty deposit!

That was at a 3.09 per cent interest rate, but to get the mortgage at all, she had to qualify for 5.09 per cent under the mortgage stress test. (The new rules now apply to those with a 20% down payment as well, and  require that you establish you are able to pay your mortgage as if the interest rate was a full two per cent higher than whatever you can actually secure.)

It got me thinking about how the mortgage stress test impacts new buyers. Here’s my hypothetical:

Let’s assume a first time buyer has saved $ 16,500 as a down payment. They want to buy a modest home: in Ottawa, a one bedroom  downtown condo or a three bedroom townhouse in say, Hunt Club, runs about $ 350,000, so they have the 5% minimum down payment they need. We’ll assume that our hypothetical buyer has no student debt and that they don’t have a car.

You can find a 3.09% interest rate right now if you have a good mortgage broker for a five year term with monthly payments. As mentioned, the stress test requires that you qualify at 5.09 per cent, or two per cent over your actual rate. When I plug those numbers into a mortgage calculator, I get this:

mortgage

 

Now add condo fees (anything under $ 350/month and I’m concerned that the building doesn’t have enough money in its reserve fund) and taxes, let’s say around $ 300/month, and my hypothetical buyer has to have an after-tax income of $2,439/month. Add utilities (some of which may be included in a condo but not a freehold), and we’re up to around $ 2700/month. If they have a car payment or student debt, they will be well over $ 3,000/month. That doesn’t include credit card payments, clothing, food, phone or internet.  Not too many first time buyers that I know are earning that kind of money after taxes. And that’s without setting anything aside for contingencies.

So what’s the impact of the  stress test? Well, it’s probably going to take longer for higher priced homes to move because those same considerations apply to all buyers who apply for financing.  It’s a whole lot harder to get a mortgage than it was a year or two ago. (I’ve read in other analyses that a buyer with a 20% down payment who qualified for  a $ 720K purchase last year  qualifies for $ 570K this year, under these new rules. That’s a huge drop in buying capacity!)

As long as our housing inventory stays low –we’re down around 27 per cent, year over year in terms of the number of overall listings– I think we’ll still see a pretty brisk market. Right now, we have so few properties to sell that anything decent is selling quickly, often with multiple offers. Ottawa is also seeing an increasing number of foreign buyers and buyers from other provinces, because it’s so affordable by comparison to places like Toronto and Vancouver.  Many of them are cash buyers, so the new mortgage rules don’t apply to them at all.

But for first time buyers, it’s getting a whole lot tougher to purchase, and every time the interest rates go up, it gets even  harder. Which means  the rental market is likely to tighten, so I expect rents to go up. We may see more purpose-built rentals as developers realize that they can rent more easily than they can sell to this demographic but that takes time so it’s probably going to get harder to find nice places to rent as well.

Those small condos and townhouses priced at $ 350K are going to get snapped up quickly, which will drive the prices up, making them even less affordable for first time buyers.

The federal government announced a policy last year of wanting to make housing more affordable for first time buyers. As I’ve shown, the new mortgage stress test has the opposite effect in the very price range that first time buyers need access to. It’s that old law of unintended consequences. The stress test assumes that interest rates will go up (I agree). But it ignores the fact that after five years, most first time buyers will have see their income increase and their monthly mortgage payments decline, as they pay off principal. And surely someone with 20% down has enough equity to protect lenders — there is absolutely no reason that I can see for the new stress test to apply to them too.)

With the spectre of higher interest rates ahead, and prices still relatively low, I do think this is the time to buy, but man, I feel for those first time buyers who really want to get into the market and just can’t get there.

 

 

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