On April 19th, 2010, the Department of Finance will be introducing what they describe as “measured steps to support the long-term stability of Canada‘s housing market.”
These steps are a number of changes to mortgage underwriting guidelines for mortgages that will be insured by CMHC, the Canadian Mortgage and Housing Corporation. Genworth, a competitor of CMHC’s, has already said that they will adopt the majority of these new rules as well.
Travis Ashclarke is a Certified Financial Planner and Accredited Mortgage Professional with Dominion Lending in Vancouver
For further insight and clarity into how these rule changes might affect us, I turned to Travis Ashclarke.
Biography: Travis has worked in the mortgage industry for the past 10 years. He spent the first 8 years of his career with one of Canada’s largest credit unions where he provided both residential and commercial mortgages. Travis has been working as a mortgage broker since December 2008. He currently works for Dominion Lending Centres in Vancouver where he assists his clients in obtaining residential and commercial mortgages. Travis holds both the Certified Financial Planner (CFP) and Accredited Mortgage Professional designations (AMP).
Enter Travis:
For most borrowers, the typical insured mortgage is one that has a loan to value of 80% or greater. This means that these new rules will have to be observed for any borrower that does not have a down payment of at least 20% or for people that are looking to refinance their mortgage to a loan to value of greater than 80%.
The new underwriting guidelines can be broken down into the following categories:
Qualification Rate
Borrowers applying for a mortgage term shorter than 5 years or a variable rate mortgage of any term will now have to qualify at the greater of the contract rate or the Bank of Canada benchmark rate. For mortgage terms of 5 years or greater, the contract rate will be used for the calculation of debt servicing.
The benchmark rate can be found here Near the bottom of the page you will find Other Interest Rates. You want the chart that says mortgage rates and the row that says 5 year. It is the series V121764 that you want to click on.
Bank of Canada 5 Year Conventional Mortgage Interest Rate March 2010
Using March 17th rates as an example, someone looking to qualify for a variable rate or a 1 to 4 year term would have to do so at an interest rate of 5.25%. For people looking for a 5 year term, they will qualify at a rate of 3.69% to 3.89% depending on the lender.
The real world effect of this will be to push any borrower with less than 20% down, who wishes to extend their purchasing power as far as possible, into a five year term.
At today’s rates, the difference in qualifying amount between the Benchmark rate and the 5 year contract rate is reasonably significant. Using the median income in Canada for a family of 2 or more, which is $66,343 according to Stats Canada; it is the difference between purchasing a home for $357,000 and $430,000. This assumes a 95% ltv, average credit bureaus, and non-mortgage debt of about $300 per month and an amortization of 35 years.
According to the finance department, their intent is to make people better able to absorb increases in rates.
The problem is that if a borrower qualifies for a 5 year term at the low contract rate, they’re not in a position to absorb an increase in rates. This is especially true for buyers that take a 35 year amortization. For those buyers who use a 25 year amortization, the slightly shorter term may help a little because a bit more mortgage will have been paid off.
The drawback to people taking a five year term to qualify for a larger mortgage is that a buyer who takes a five year term is giving up the flexibility of having a shorter term. This flexibility is fairly significant since according to CMHC’s statistics, a majority of people that take a 5 year term end up breaking it in 3 to 4 years and paying a penalty to do so. This could be due to either refinancing or due to selling the home and moving. To protect themselves, borrowers should make sure that their mortgage is portable so they do not have to break the term if they move before their 5 year term is up.
Revenue/Investment Properties
The most significant change is for people that are looking to purchase a revenue/investment property.
People purchasing a non-owner occupied investment/rental property will now be required to have a minimum down payment of 20% for an insured mortgage.
Currently, the minimum down payment required is 5%. It’s worth noting that a year and a half ago a person could get 100% financing on an investment property so this is a fairly large change in a short period of time.
In addition, rental income will now be used differently in debt servicing calculations. Previously, 80% of rental income from the subject property and all other properties owned could be used to reduce the mortgage and debt payments in the Total Debt Servicing ratio. The new rule is that 50% of the gross rental income will be added to the borrower’s gross income for the purposes of debt servicing.
This will make it much harder to debt service a mortgage using rental income.
The purpose of this change was to remove speculation from the rental/investment market.
Genworth has announced that they will add 100% of the rental income to gross income for debt servicing.
The majority of people purchasing rental properties are usually doing so with at least 20% as a down payment anyway in order to avoid paying a high ratio insurance fee, so the down payment rules won’t affect a lot of people.
People who are purchasing a home with a basement suite with the intention of that suite helping them qualify for the mortgage, will find that it doesn’t help as much as it used to.
Refinancing
The maximum allowed refinance/equity take out is now 90% of the value of the home. Previously it was 95%. According to the Finance Minister, the purpose of this was to make home ownership “a more effective way to save.”
The number of people refinancing up to 95% is fairly small due to the additional cost of the high ratio insurance, so this won’t affect many people.
The benefit of this is it will protect equity in the event of a drop in housing prices. The drawback is that people with very high interest debts that would benefit from consolidating through a housing refinance will no longer be able to do so past 90%.
Conclusions
While reading new department of finance rules probably makes for dry reading, the truth is that for some people in the mortgage industry, these rules will have a profound effect on their business.
Smaller mortgage lenders will be forced to compete head to head with the big banks in the area of the 5 year mortgage term which typically has lower margins.
First time buyers, who for the most part have less than a 20% down payment, will have less flexibility in term choice if they want to get a larger mortgage and, having qualified at a low rate, will still not be in a position to better absorb an increase in rates as the government had intended with these rule changes.
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