Changes to the mortgage qualification rules could have a significant impact on residential real estate sales, particularly condominium pre-sales.
There have been six changes to the rules, the first three having been announced on April 19, 2010 and others having been announced on January 17, 2011. The changes are set out below:
- Purchasers must qualify for a five-year, fixed-rate mortgage. Previously, purchasers only had to qualify for the less conservative three-year, fixed-rate mortgage.
- Homeowners may only re-finance up to 90% of their home value rather than the previously permissible 95%.
- The minimum down payment for properties that are non-owner occupied increased from 5% to 20%.
- The maximum amortization period for a government-insured mortgage has been reduced from 35 to 30 years.
- The maximum amount a homeowner can borrow against his or her home equity has been reduced from 90% to 85%.
- The government will no longer insure home equity lines of credit.
Undoubtedly the purpose of the changes is to prevent Canadians from overextending themselves financially, thus putting themselves in a precarious financial position. However, these changes are not only prospective in nature. The changes apply to all residential sales regardless of whether the contracts of purchase and sale were entered into before or after the changes were announced.
Pre-sale contracts are typically entered into many months or even years prior to closing. In those instances there is no mortgage pre-approval until near the time of closing. In effect the purchaser is betting that he or she will qualify for a mortgage and be able to come up with the required down payment, or that the deposit already paid will be sufficient to cover the down payment requirements
The effect of the mortgage rule changes on pre-sales
It is not expected that all of the mortgage qualification rule changes will effect condominium pre-sales. However, three changes are expected to impact pre-sales contracts. In particular, the parties to existing pre-sales contracts that have not yet completed may be significantly affected by the changes.
- Tougher mortgage qualification standards
While some purchasers may have qualified for the required mortgage under the old qualification standards, they may not qualify for the more conservative five-year, fixed-rate mortgage. This could preclude the purchaser from completing the purchase and potentially forfeiting the deposit.
- Increased down payment for investment properties
Real estate, particularly pre-sales, has been a popular way for British Columbians to invest their money. The quadrupling of the minimum down payment for such purchases poses perhaps the biggest threat to pre-sale purchasers.
Many pre-sale purchasers pay a deposit of 10% - 20% of the purchase price. The purchaser is often betting that this deposit will be sufficient to meet the minimum down payment requirements and no further outlay of cash will be required at closing. The increase in the minimum down payment may result in a previously unexpected expense at closing time. Any decrease in the market only serves to exacerbate this problem. When the residential real estate market decreased markedly in late 2008, we saw many purchasers who had paid deposits that were not enough to make up the difference between the purchase price and the market value of the unit. In order to complete, those purchasers had to make up that difference plus pay the 20% down payment and HST. For example, if one purchased a pre-sale investment property at a price of $400,000 and paid a 15% down payment ($60,000) and the property decreased in value by 10% at closing (to $360,000), the purchaser would be required to come up with $52,000 cash at closing, plus HST, in order to even be considered for a mortgage.
- Reduced maximum amortization period
The reduced amortization period will have the effect of reducing the amount of the mortgage for which a purchaser qualifies. For purchasers of pre-owned or already constructed real estate, this will simply limit the amount they can spend on a home. However, a pre-sale purchaser (particularly one who has already entered into a contract), may no longer be able to qualify for the necessary mortgage to complete the transaction. This could lead to a default and forfeiture of the deposit.
While the new mortgage rules are applauded by many as a prudent step, the effect on existing pre-sale contracts creates a, perhaps unintended, risk to all parties to those contracts. It would be prudent for both sellers and purchasers to seek professional advice and take appropriate steps in advance of closing in order to minimize their financial and legal risk.