On Jan. 1, the Canadian government started requiring the country’s major banks to “stress test” hopeful mortgage lenders, effectively making it much harder for most people to qualify for a mortgage loan.
Given how high home prices are across much of the country, especially in major cities like Vancouver and Toronto, this was not great news for prospective homebuyers. Saving enough for a down payment — which, in Canada, amounts to 5% of a home’s purchase price, or 10% on any amount above $500,000 — is hard enough. Adding a stress test that requires you to prove that you have even more money? It certainly doesn’t make things easier.
But maybe that’s not an entirely bad thing. It’s key to understand that the federal government did not introduce the stress test solely to be a downer; the test’s purpose is to weed out prospective homebuyers who are at risk of not being able to keep up with mortgage payments. After all, low mortgage qualification rates in the U.S., and the housing bubble that followed, was one of the triggers of the 2008 financial crisis — which led to massive job losses, devalued homes, and taxpayer-funded bank bailouts.
All that being said, people still need a place to live. If you’re one of those people who are tired of renting, but are finding it harder to qualify for a mortgage from a traditional lender — e.g., a bank — under the new stress test rules, chances are that you’ve come across the term shadow lenders, alternative lenders and private lenders in your research.
Essentially, people are looking outside the traditional lenders to qualify for a mortgage. But if you’re going that route, it’s important to understand what you’re getting yourself into.
We’ve talked to Shawn Stillman, a mortgage broker at Toronto-based mortgage company Mortgage Outlet, to find out more about these lenders. Can you trust them? How do you know if you’re getting a good deal?
When you’re looking for a mortgage, there’s a variety of different lenders out there. “A lenders,” or traditional lenders, refer to banks and credit unions that cater to customers with good credit scores and a reliable income — these are considered an “A” clientele. The majority of people looking for mortgages have traditionally gone to these lenders.
Institutions servicing an “A” clientele include Canada’s major banks — e.g., BMO, CIBC, National Bank of Canada, Scotiabank, RBC, and TD. These banks are subject to federal regulation, which means that you’ll be stress tested when you apply for a mortgage. The stress test involves finding out if applicants can afford to pay interest at either the five-year average posted rate, or two percentage points higher than the rate their bank or broker offers them — whichever is higher.
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Many credit unions also cater to a primarily “A” clientele, but, they are not federally regulated. They’re regulated by provincial governments. This means that they did not have to adopt the stress test rules come Jan. 1, but some of them are starting to rework their mortgage lending guidelines so that they align with the stress test rules, in order to protect their own interests, and their customers.
Stillman says that established banks and credit unions typically lay out the terms of their mortgages very clearly. If you don’t understand a clause, ask questions until you do; never sign anything — especially anything as potentially life-changing as a mortgage — without understanding what it entails first, Stillman advises.
There are more than six banks in Canada, obviously. Equitable Bank and Home Capital are examples of institutions that offer options for a “B” clientele.
These institutions offer a lower barrier of entry to qualifying for their products, but can offset that with higher interest rates. In short, they cater to people who may not qualify for say, a mortgage or a credit card at one of Canada’s six big banks, because they lack either a strong credit history, or a guaranteed income (recent immigrants, or the self employed, for instance).
But when it comes to mortgages, the deal might be worse. A mortgage is a loan that is given to you under specific conditions, and it’s necessary to take a good look at the conditions that B lenders are offering you to ensure that you won’t get trapped with high interest rates you can’t afford.
Unregulated or private lenders
Unregulated lenders could span anyone and anything from individual lenders like your parents, or businesses that specialize in mortgages but are not subject to the same regulations that banks and credit unions are.
Stillman refers to this sector of the mortgage market as “the wild west.”
Because, this is where things can get sketchy. Unregulated lenders aren’t required to stress test mortgage applicants, but they tend to abide by lower qualification rates anyway; getting approved for a mortgage loan at an alternative lender can be much easier than getting approved for the same loan at a traditional bank or credit union.
As with B lenders, it’s incredibly important to pay close attention to the deal that an unregulated lender is offering you — in our experience, lower qualification rates tend to come with baggage.
What you need to look out for when considering an alternative lender
Stillman identifies five questions that you should always — always! — ask when you’re looking at a mortgage agreement:
- How high is the interest rate?
- If you can’t make a mortgage payment, what is the penalty? How is it calculated? What will it cost you to get out of the mortgage altogether?
- Is there a prepayment privilege — e.g., can you avoid paying penalties if you decide to give the lender a larger-than-usual mortgage payment one month?
- What is the amount of money that you need to put into each monthly mortgage payment?
- What does the fine print say?
Do not sign anything until you have satisfactory answers to each of these questions. And again, if you don’t understand what you’re looking at — ask questions; don’t be afraid to sound stupid.
Get a lawyer
This is non-negotiable when you’re considering a private loan. And this folds neatly into the point about understanding what you’re signing up for: a lawyer you trust can help clarify, and potentially identify, risky clauses.
“The number one thing that I always say is have your lawyer review the documents,” says Stillman.
“Not a lawyer the lender suggests... You need a lawyer that represents your interests in these transactions.”
Know the mortgage rules in your province
Because alternative lenders are not subject to the same regulations as banks and credit unions, they can charge unconventional fees — some of which may turn out to be illegal.
In Ontario, for instance, it’s illegal for any mortgage brokerage to charge you an upfront fee if your mortgage amounts to $400,000 or less. Check the provincial regulations in your own province to find out whether advance fees are legal or not.