When the Office of the Superintendent of Financial Institutions’ (OSFI) implemented new rules earlier this year designed largely to cool the red-hot housing markets in Toronto and Vancouver, many economists lauded the move.
Indeed, housing affordability has emerged as a major issue in Canada in recent years, particularly in our largest cities. Many homes that were considered well within reach of middle income earners a half decade ago, now sell for $1 million or more. In fact, the average price of a detached home in Toronto and Vancouver cleared that important price point months ago. Many Canadians are being forced further out of major centres such as these in search of cheaper rents or more affordable homes to purchase in the surrounding suburbs or bedroom communities.
While those changes did their job—according to the Bank of Canada, year-over-year home price increases have declined to about 1.5 per cent nationally, compared to 20 per cent in April, 2017—there has been collateral damage. Entrepreneurs on the hunt for their first home, typically in their late-20s or early 30s, are facing a significant uphill climb to realize their dream of home ownership.
But they own their own businesses—buying a home should be a breeze, right? Not so fast. We work with entrepreneurs on a daily basis, and we know that when those business owners are in the start-up phase, their personal financial situation can be especially precarious. In many cases entrepreneurs will forego a salary in the first year (even two) of the operation of their business. Others will take a meagre salary just to get by, and often ‘max-out’ everything from credit cards to lines of credit simply to keep their businesses afloat. They are usually anything but cash rich.
In all but a slim handful of cases, shelling out huge sums for a new home is not an option.
The OSFI’s new rules introduced a new minimum qualifying rate for uninsured mortgages, which includes situations where buyers are making a down payment worth less than 20 per cent of the mortgage’s value. Previously, home buyers who chose a five-year fixed mortgage and made a 20 per cent down payment on a new home could qualify for a mortgage based on their ability to afford payments using the current five-year fixed mortgage rate as a benchmark. Now, qualification will be based on the higher of the five-year Bank of Canada benchmark rate or the contract rate plus an additional 2 per cent.
Not surprisingly, so-called stress tests such as these have pushed many first-time buyers out of the market. By some estimates, many home buyers will see their purchasing power slashed by as much as 20 per cent.
These developments only underscore the importance of having a detailed financial plan when founding a new business, one that takes into account your personal financial goals, as well as your growth plans for the company. If growing that new business is your aim, then plans for home ownership might have to be shelved in the near term until your new business achieves profitability, clears the treacherous start-up phase when more than 80 per cent of new companies disintegrate, or both.
Becoming financially over-extended as you attempt to both finance a business and a new home purchase not only has the potential to tax your personal finances, but can also impact your ability to grow the business given how tightly entwined entrepreneurs’ personal and corporate financial fortunes tend to be in those early years.
That’s why it’s imperative to work with your accountant and financial advisor to develop a home-buying budget. This could involve some very tough decisions to scale back your target price point, or forego a home purchase altogether. Upon conducting a detailed analysis of your personal financial circumstances, for example, a qualified chartered professional accountant might recommend renting for a time until your business becomes a going concern. Regardless of the advice that trusted advisor provides, what’s important is to take the time to obtain a third-party perspective that provides you with a clear overview of your unique financial situation.
The OSFI’s new rules are restrictive at first glance, but they’re also positive in the sense that they force young entrepreneurs to evaluate their circumstances and make prudent (if difficult) decisions. I can say from experience that when you’re trying to build and grow a business, the last thing you want to manage is the stress that comes with carrying a crippling personal debt load. In that sense, maybe there’s an upside to these new mortgage rule changes.
Adriano Romeo, Partner