What first-time home buyers need to know

The Home Buyers’ Plan and the mortgage stress test

Shopping for a new home? Welcome to the crowd. The residential real estate market is hot in all of Canada’s major urban centres and surrounding areas, mostly because of the current environment of ultra-low interest rates. New home buyers face two hurdles: the mortgage stress test and the down payment. Here’s what you need to know.

The Canadian Real Estate Association’s March report showed a 15.7% increase in newly listed properties from January to February. Significantly, the MLS Home Price Index was up 17.3% year over year, while the actual national average sale price surged 25% year-over-year in February. In Toronto, the average home price exceeded $1 million in February, according to the Toronto Real Estate Board.

According to the rules set out by the Financial Consumer Agency, you will need a 20% down payment for a home priced at $1 million or more (it scales down for homes priced below that level). That $200,000 is a stretch for most young couples starting out. Most will raid savings and investment accounts to top up their down payments. Many will get help from parents or grandparents through loans or outright gifts.

Home Buyers’ Plan

And many will dig into their Registered Retirement Savings Plan (RRSPs) under a federal government plan called the Home Buyers’ Plan (HPB). If you’re a young couple, the HBP could mean as much as an extra $50,000 to tack on to a down payment.

Essentially, the HPB allows first-time home buyers who meet certain conditions to withdraw up to $25,000 from their RRSPs in a calendar year to buy or build a qualifying home. Even better, that amount will not be included in your income and tax will not be withheld on the withdrawal.

The downside of the HBP is that you’re taking money out of your RRSP, so it will no longer be growing and compounding within the plan on a tax-deferred basis. However, because you’re putting the funds towards the purchase of residential real estate, you may still come out ahead. That’s because any realized gain in the value of your property when you sell is covered by the Principal Residence Exemption, so you won’t pay tax on any capital gain on your home when you sell. In addition, you have to repay the HBP withdrawal back into your RRSP on a regular basis over a maximum of 15 years, so you’ll still be rebuilding your RRSP over time.

In Canada residential real estate, especially in larger urban markets, has historically been a good investment, at least keeping pace with the rate of inflation, and often exceeding it by a wide margin. So if you choose the right home in the right location, anything you give up in your RRSP in terms of growth you’re likely to make up in the increase in value of your real estate. But this is always something of a crapshoot. Consider your HBP withdrawal as a source of funds for a place to live, not as a speculative real estate venture!

To make an RRSP withdrawal under the HBP, you have to be a first-time homebuyer, it must be your principal residence, and you must have a written agreement to purchase by Oct. 1 of the year following your withdrawal. You must also complete and file CRA Form T1036-17e. The Home Buyers’ Plan can be complicated, so getting advice from a qualified financial planner ahead of time is a good idea.

Stress test

Once you’ve got your downpayment together, you’ll still have to jump through some hoops to get a mortgage.

The so-called “stress test” for those seeking residential mortgages is a federal government-mandated requirement issued by the Office of the Superintendent of Financial Institutions (OSFI), so there’s no escape. Anyone borrowing from a lender subject to federal regulation (and that includes just about every financial institution in Canada) will have to pass the OSFI Mortgage Stress Test in order to be approved for a mortgage. And note, this now applies to all borrowers, including those making down payments of 20% or more, who typically don’t need mortgage insurance.

Applied to the loan application, the stress test will look at such things as how much you’ll be able to afford with your current debt-to-income ratio, and whether you’d be able to continue making payments if interest rates rise or you lose your job. But the kicker is that even if you qualify for a mortgage at a current contracted rate today, you’d still have to qualify for a mortgage at an even higher rate, which is calculated as the greater of your mortgage interest rate agreed to by your lending institution and the Bank of Canada’s 5-year mortgage benchmark rate, which is about two percentage points more than the typical contracted mortgage.

The stress test has the effect of cutting your borrowing capacity substantially. If you don’t pass the stress test at the higher rates, you won’t qualify for the mortgage. Most at risk are those who have stretched their budgets to the limit in seeking the kind of house they want. For those in this position, the result is that you may be forced to revise your expectations and look for a lower-priced home.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.