The new mortgage rules don’t do homebuyers any favours.

If you’re buying a home with less than a 20 percent down payment, the rules of the game have changed. In an effort to avoid a U.S.-style housing crash, the federal government has introduced a new set of mortgage rules designed to cool the real market and orchestrate a “soft landing.”

The government is once again cracking down on foreign buyers. It’s closing a tax loophole whereby non-residents could avoid paying capital gains tax by claiming their home away from home in Canada as their principal residence  – after this week’s announcement that’s no longer the case.

While I applaud the government in ensuring foreign buyers pay their fair share of tax, what’s getting all the attention are the new mortgage qualification rules. Under the existing rules, the bar was set higher for high-ratio mortgages (those making less than a 20 percent down payment), specifically for variable rate mortgages and fixed rate mortgages terms under five years. You had to qualify based on the Bank of Canada’s inflated benchmark qualifying rate; it currently sits at 4.64 percent (in case you’re wondering, the qualifying rate is a mode average of the big six banks’ posted five-year fixed mortgage rates). The so-called “stress test” is to ensure you can afford higher mortgage payments if rates are higher when you renew your mortgage.

Before this week’s announcement, you could avoid qualifying under the stricter rules by choosing a five-year fixed rate mortgage. Instead of qualifying based on the higher posted rate, you could qualify based on the lower discounted rate.  That’s no longer the case. Starting October 17, all insured mortgages, including five-year fixed rate mortgages, must use the higher qualifying rate.

What Do the New Rules Mean for Homebuyers?

If you’re a homebuyer in a high-priced real estate market like Toronto or Vancouver where it’s just not realistic for most to save a 20 percent down payment, the new qualification rules will have a major impact on how much house you can afford. Mortgage-rate comparison website RateHub.ca went ahead and crunched the numbers. Under the current rules, if you had an annual income of $100,000 and a modest down payment of $40,000, at a mortgage rate of 2.17 percent, you could spend up to $665,435 on a home. However, under the new rules, you’d only qualify for a mortgage of $521,041. That’s a difference of $144,304 – ouch!

The Debt Service Ratios Flaw

Besides the qualifying rate, another ways banks determine whether to approve your mortgage is debt service ratios (gross debt service ratio and total debt service ratio). But the debt service ratios lenders use are flawed. The debt service ratios only look at the percent of your gross monthly income needed to cover your monthly mortgage payments, property taxes, heating costs and 50 percent of condo fees (if applicable).

The first flaw is that gross monthly income is used. I don’t know about you, but last time I checked I get paid in after-tax, not before-tax, dollars. (Not to mention, what if your spouse loses their job and your family’s income is cut in half? The debt service ratios don’t consider that either.) The second major flaw is that other costs related to homeownership – hydro, water, home insurance, repairs and maintenance – aren’t consider in the debt service ratio. It’s up to you to budget for those.

Have the New Rules Gone Too Far?

There’s no denying a housing crash would be catastrophic for most (except maybe first-time homebuyers who have been priced out of the market), but have the new rules set the bar too high for first-time homebuyers?

Before the new rules, it was already challenging to afford a house in Canada’s big cities. This has only been made more difficult. Even if you’re willing to scrimp and save and live a home with mom and dad for a few more years, it could still take quite a while to save up enough for a down payment.

But don’t throw in the towel on homeownership just yet. There are still ways to buy a home. You just have to be creative like making a withdrawal from the bank of mom and dad. While I’m not a fan of parents gifting their adult children their entire down payment, there’s ever the more reason for parents to top up their children’s down payment to reach 20 percent and avoid the stricter qualifying rate.

It has been suggested a third of insured mortgages would have ‘difficulty’ under new federal rules. Does that mean a third of homebuyers won’t purchase a home after the new rules are in place? Of course not! Similar to how homeowners managed to deal with mortgage rates above 20 percent in the 1980’s without losing their homes (the mortgage default rate was less than 1 percent), homebuyers will adjust. If it means buying a smaller house, so be it. The silver lining to this is that it will be more of a financial cushion for when mortgage rates eventually rise.

Buying a Home is Still Realistic – You Just Have to Be Smart About It

If you’re not happy with your new housing budget, you have two choice: you can save at least a 20 percent down payment to avoid the new mortgage rules by qualifying based on the lower discounted rate or you can find a better-paying job (easier said than done) to qualify for a bigger mortgage. However, there’s a third choice you may not have considered: reducing your housing budget.

A mistake that many first-time homebuyer make (I discuss it in my book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom) is “buying too much house.” Just because your banks says you can spend $665K on a home, doesn’t mean that you should. Your banker and realtor aren’t going to say you to spend less. It’s up to you to decide how much you feel comfortable spending. Take the time to prepare a budget and see if you’re comfortable with your monthly mortgage payments. The last thing you want to be is “house rich, cash poor” with little money left over to save, let alone to have fun.

If you’re not comfortable with your mortgage payments, you’ll have to make the tough decision of reducing your home-buying expectations. Remember, you don’t have to go out and buy your dream home right away. You might be able to find a home that covers most of the things on your wish list at a price you feel comfortable at. Best of all, a smaller mortgage means you’ll be able to throw a mortgage burning party for the ages that much sooner.

Are you affected by the new mortgage rules? Do you plan to lower your housing budget?

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians, available now on Amazon and at Chapters, Indigo and major bookstores, and as an Audiobook on Amazon, Audible and iTunes.