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A major shift in mortgage rules means that Canadians taking on loans to buy homes may not qualify to borrow as much as they previously could.

The rules announced by federal Finance Minister Bill Morneau are aimed at making sure homebuyers arent taking on mortgages they cant afford if interest rates rise. The change means that all homebuyers, regardless of how much they have for a downpayment, will be subject to a mortgage rate stress test beginning Oct. 17 that has, up until now, been reserved for those with less than 20 per cent down.

The big change

Buyers with a downpayment of between five and 20 per cent who hold what are known as high-ratio mortgages must be backed by mortgage insurance to protect the lender in the event the homeowner defaults on the loan.

Because they are considered higher risk, those buyers must pass whats called a mortgage rate stress test to qualify for insurance backed by the federal government through the Canada Mortgage and Housing Corp.

That stress test measures whether the buyer could still afford to make payments if mortgage rates rose to the Bank of Canadas posted five-year fixed mortgage rate.

That rate is usually significantly higher than what a buyer can negotiate with banks or other lenders. For instance, TD has a five-year fixed rate mortgage at 2.59 per cent, while the Bank of Canadas rate is 4.64 per cent.

The stress test also sets a ceiling of no more than 39 per cent of household income being necessary to cover home-carrying costs such as mortgage payments, heat and taxes.

Until now, buyers with more than a 20 per cent downpayment have escaped such scrutiny.

The federal government says its responding to concerns that sharp increases in housing prices in Toronto, Vancouver and elsewhere could increase defaults in the future, should historically low interest rates finally start to climb.

Other changes

The government is also instituting changes aimed at foreign buyers, big banks and lenders and mortgage insurance on homes valued at more than $1 million.

As it stands, those buying a home with more than 20 per cent down could obtain low-ratio insurance to protect the loan against default. That insurance is sold through two private insurers, but is backed by the federal government, subject to a 10 per cent deductible.

Beginning Nov. 30, new criteria will be in place governing the low-ratio insurance. To qualify, the mortgages amortization period must be 25 years or less, the purchase price must be under $1 million, the property must be owner-occupied and the buyer must have a credit score of 600 or more.

The new rules also mean that, beginning this tax year, all home sales must be reported to the Canada Revenue Agency. The gains from sales of primary residences will remain tax-free, but the government is aiming to block foreign buyers from purchasing and flipping homes while falsely claiming the primary residence exemption from capital gains tax.

Finally, the government says it will shift some of the risk of defaults against insured mortgages to banks and other lenders. Ottawa says its shouldering 100 per cent of the cost of a defaulted mortgage is unique in the world. How the government plans to share some of that risk with lenders remains to be seen. But experts say, while it protect the government from widespread defaults, it could lead to higher interest rates for borrowers.

Robert McLister, writing for Canadian Mortgage Trends, says Ottawa is cracking the housing market with a sledgehammer.

He predicts consumers will bear the brunt of the blow and that housing prices will tumble because a sizable minority of first-time and high-ratio buyers will no longer qualify for the mortgage amount they want.
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