In the midst of the COVID-19 pandemic, while many business sectors were grappling with mass closures and economic downturns, the real estate market in Canada was thriving. Fueled by historically low interest rates, individuals were eager to invest in property. However, the winds have shifted, and now the once-booming market is facing challenges. This blog will explore the reasons behind the recent mortgage rejections and shed light on what happens when a real estate agreement falls through due to financial constraints.
Part 1: Why Mortgage Approvals Are Becoming Elusive
- Rising Interest Rates and Inflation: Despite the Bank of Canada maintaining a five percent interest rate, inflation has become a formidable opponent. Those with variable mortgages obtained during the pandemic are finding it challenging to cope with increased inflation and interest rates Canada. Even individuals with fixed mortgages are anxious about qualifying for renewal when the time comes. According to the Central Bank of Canada, the total amount of mortgage loans to be renewed during 2024-2025 is close to 40% of the Canadian economy.
- Mortgage Stress test: New residential mortgages in Canada undergo stress testing to evaluate the borrower’s ability to afford payments, not only in the present but also in the future, reducing financial system risks. Changes in the 2021 stress test include raising the ratio to 5.25, increasing the difficulty of qualifying for a home loan thereby reducing the pool of eligible borrowers.
- Low Appraisal Values from the bank: With home prices experiencing a significant 6.5% drop, the appraisal values are falling below the purchase price. This leaves buyers receiving less mortgage funds from the bank than the required amount for the down payment, leading to failed closings.
Part 2: Actions Buyers Could Take When Facing an Unsuccessful Closing
This list is not exclusive; further remedies depend on the circumstances.
Mutual Release: A crucial document in cases where a deal is unable to close due to the buyer or seller not meeting conditions is the Mutual Release. It clarifies deposit distribution and ensures that all parties, including realtors, agree to end the agreement without pursuing legal action against each other.
Some protections that parties to a real estate transaction can include in their contract are the following:
- Force Majeure (Contractual): If a Mutual Release is not an option, some contracts may include a force majeure clause. This legal remedy temporarily suspends rights and obligations in the face of extraordinary events beyond human control such as earthquake or war. However, the standard OREA agreement of purchase and sale does not inherently contain this clause.
- Frustration (Common Law): In the absence of a force majeure clause, purchasers may seek relief under common law through the doctrine of frustration. This is when an event occurs, post-contract formation, that makes it physically, legally, or commercially impossible to fulfill the agreement. It provides a remedy if the contract’s nature transforms into something radically different from the original plan, making enforcement unjust.
Key Takeaway
As Canada inflation and interest rates soar high, purchasers facing mortgage rejections find themselves at a crossroads. Understanding the available remedies and incorporating these solutions into the contract can provide a shield. The court upholds the contract, as evident in the case of FSC (annex) Limited Partnership v. Adi 64 Prince Arthur, where the court stated that, “If decreased liquidity was tantamount to frustration, it would mean that a large number of contracts for which parties required financing would be frustrated in every recession.”
