In anticipation of potential interest rate declines , many prospective homebuyers are wondering if qualifying for a new mortgage will become easier. However, upcoming changes from the Office of the Superintendent of Financial Institutions (OSFI)  may complicate these plans. Beginning in the first quarter of 2025, a new loan-to-income (LTI) cap will be implemented to prevent banks from extending excessive credit to overleveraged buyers. This cap restricts banks from holding too many mortgages where the loan amount exceeds 4.5 times the borrower's annual income.

This regulation will predominantly affect new home purchases  and is likely to have the most significant impact on first-time buyers, who already face challenges in accessing the housing market. The rule currently applies only to uninsured mortgages—those for borrowers with a 20% down payment who, unlike those with less than 20%, are not required to buy mortgage insurance—, which lack government protection and present a higher default risk to lenders.

Under this new framework, purchasing a home,with a down payment of 20% or more might trigger the LTI limit, affecting the buyer's borrowing capacity. This is especially relevant in expensive markets like Vancouver, Toronto, and Calgary, where buyers often need to borrow more than 4.5 times their income to enter the real estate market.

For example, under current regulations, purchasing a $600K property with a 20% down payment results in a $480K mortgage. With a 5% interest rate and a 2% stress test, the total effective rate is 7%, and an annual income of $100K comfortably meets the Total Debt Service (TDS) ratio below 44%. However, with the introduction of the new LTI rule, this same scenario changes. Even if interest rates drop to 3.25% next year, allowing for more affordable monthly payments and easier qualification under the stress test (3.25% + 2%), the LTI rule becomes a hurdle.

The mortgage amount of $480K, when divided by the annual income of $100K, results in an LTI of 4.8%, surpassing OSFI's maximum LTI threshold of 4.5%. This means that despite lower interest rates making monthly payments more manageable, the LTI ratio would prevent qualification under the new guidelines.

However, OSFI has indicated that banks will have individual quarterly limits for mortgages that do not conform to the LTI guideline, suggesting that applicants could still be approved but possibly at higher interest rates ????. This premium compensates for the risk associated with mortgages that exceed the standard LTI limit, utilizing the bank's allowance for non-qualifying LTI mortgages.

Banks will face quarterly caps on high-LTI loans, and the specifics of these limits will vary by institution, depending on their risk profile and history. The impact on mortgage availability may become more pronounced throughout the year, potentially leading to higher interest rates or declined applications for those exceeding the 4.5% LTI limit.

In summary, the new LTI regulation, set to take effect in Q1 2025, will necessitate careful financial planning  for prospective homebuyers in Canada, involving both you and your mortgage broker. Those with high LTI ratios may need to explore alternatives such as applying for mortgage insurance, paying higher interest rates, or switching to alternative or private lenders. In any scenario, it is always wise to consult with your trusted mortgage broker  to determine the best course of action.