Buying a home is one of the most important decisions you'll ever make, so it pays to spend some time learning about relevant laws and expert advice on the subject. Let's take a look at two terms you should know about and why they're important in the process of getting approved for a mortgage.
The election of the Liberal government in 2015 has led to a number of reforms designed to ensure Canadians don't take on mortgages they can't afford. Some of these changes address restrictions on foreign buyers and so-called "flippers" who frequently buy and then resell homes. In this article, we'll focus on just the changes involving down payments.
The new law states that anyone buying a home who has a down payment of between 5-20% of the selling price must acquire mortgage insurance. This is designed to protected financial lenders from mortgage holders who may later default on their payments.
In the insurance industry, "high ratio" mortgage insurance (sometimes called "high loan to value" mortgages) refer to situations where the buyer has put 20% or less towards their down payment. Buyers who put 20% or more of the selling price on their down payment can get "low ratio" mortgage insurance that will guarantee the bank or financial institution is paid in the event of a default on the loan (mortgage) by the buyer. As you might guess, low ratio insurance is far more affordable than high ratio mortgage insurance.
Canadian law stipulates that all mortgage insurance in Canada is backed by the federal Canada Mortgage and Housing Corporation (CMHC). You can obtain the mandatory mortgage insurance either directly from the CMHC or from two private companies: Canada Guaranty Mortgage Insurance and Genworth Financial Mortgage Insurance Company Canada. The federal government will provide complete protection to the lender for private sector insurance, subject to a 10% deductible.
Mortgage Stress Test
Beginning in October of 2016, the new law in Canada stipulates that all mortgages will be subject to a "stress test". The test is designed to assess whether the individual borrowing money to buy the house could afford to make their payments even if interest rates were to later rise.
The stress test is based on the Bank of Canada's five-year fixed posted mortgage rate, determined by averaging the posted five-year rates from the six biggest banks in Canada. Usually, the Bank of Canada's five-year rate is higher than what commercial banks and other financial lenders are offering.
The stress test also requires that home buyers spend no more than 39% of their income on mortgage payments, mortgage insurance premiums, taxes, and basic home costs (like utilities). A second test called the Total Debt Service (TDS) mandates that a home buyer's total debt obligations do not exceed 44% of the person's income.
To get the best conditions for your mortgage and mortgage insurance, experts recommend putting 20% of the purchase price as a down payment. The average price of a new home in Canada averaged around $503,057 in 2016, making it difficult for some prospective home buyers to save the tens of thousands of dollars necessary for a down payment.
Canadian mortgage law requires home buyers to put at least 5% of the total price as a down payment in order to qualify for a mortgage. If you put 20% towards the down payment, you'll get access to more affordable insurance and have more options when it comes to financing the home you want.
The new Canadian laws are in place to ensure that home buyers can comfortably afford the mortgage on their new home. Remembering these rules now will make for an easier mortgage application process when you're ready to buy.