New Challenges for Borrowers and Brokers Alike
I have a favourite saying, which is “the only constant in life is change.” This certainly applies to the mortgage industry over the past few years.
For almost a year, we've been adapting to two major sets of mortgage changes, the insured mortgage rules imposed by Finance Minister Jim Flaherty and OSFI's B-20 residential underwriting guidelines. The latter has been causing lenders to churn out new policies seemingly every week.
These continual changes have made it increasingly difficult to qualify AAA clients. Applications that were approved a few months ago are now being declined or approved with more conditions.
What follows is a quick recap of some recent guideline changes (keep in mind that each lender is putting their own twist on every rule):
- Some lenders now factor in a monthly payment for secured credit lines with zerobalance. This means that even if a borrower isn’t using their secured credit facilities, a payment will be factored into their Total Debt Service (TDS) ratio. First National's guidelines, for example, say that even if a client owes nothing on a $100,000 secured HELOC, a payment of $383/month will be included in debt servicing. (Their calculation is: (4.6% x the line of credit limit)/12 = the payment per month). That adds almost $400/month to the TDS! For a qualified borrower with $50,000 of income and a typical 2.99% mortgage, this could reduce their maximum mortgage amount by roughly $60,000 - $70,000.
- On revolving unsecured credit, monthly payments are being set at 3% of the outstanding balance. At all but a handful of lenders, interest-only or minimum payments can no longer be used when qualifying clients. That has quite an impact. Consider that a $15,000 unsecured line of credit has interest-only payments of $75/month. Despite that, lenders routinely want a $450/month payment to be included in TDS.
- Many lenders now calculate heating costs using a specific formula based on property size. In days gone by you could input $75-85/month for heat and no one questioned it. Now, homes over 3,500 square feet have a "heat factor" of $115-$220 at some lenders. While this may be prudent, it again reduces a borrower’s potential mortgage size.
- Conventional variable-rate mortgages and fixed terms less than 5 years are now qualified using the Benchmark Rate. When implemented last year, this change had a significant impact on how much mortgage a person qualified for.
To put this last guideline into perspective, take the example of Mr. & Mrs. Smith. Both have been employed full time in salaried jobs for 3 years. Each earns $60k/year. They have credit scores over 800, a car loan with a $500/month payment and a $15k unsecured credit line with $75/month interest-only payments. Add to that RSPs worth $150k. Dream clients, right?
In 2012, the Smiths easily qualified for a $640k mortgage when they purchased their $800k family home in the suburbs. Their mortgage agent got them a great rate of 2.89% for a 5-yr fixed with Lender ABC. And it was amortized over 35 years to improve cash flow while their daughter was in university.
The Smiths recently approached their mortgage agent to inquire about refinancing. Their application was strong, with a loan-to-value of only 75%.
In 2012, the Smith’s GDS/TDS was 29/35, so their mortgage agent never expected any approval challenges. The agent prepared the refinance application for $680k and requested a new rate to be blended with the Smith’s existing rate of 2.89%. Then today’s new reality hit everyone.
Under the new rules, these applicants will no longer be approved. Here’s why:
- Lender ABC must now qualify the Smiths at the Benchmark rate of 5.14% because they’re taking a “blended” 4-year term (i.e., a term less than five years). The new qualifying rate of 5.14% is almost double their previous rate of 2.89%. That pushes the Smith’s TDS ratio well over lender guidelines
- Lender ABC can no longer offer 35 year amortizations. As a result, the Smiths are now qualified at a 30 year amortization, again raising their TDS ratio.
- The payment on the unsecured LOC has gone from interest-only at $75/month to $450/month, thanks to the mandatory 3%-of-limit minimum payment (used for approval purposes).
These changes have pushed the Smith’s ratios from 29/35 GDS/TDS (under former guidelines) to 41/50 under today’s guidelines. That’s despite no increase in their risk as borrowers.
Clearly this deal could be restructured, but it provides a very real example of the challenges now facing mortgage professionals. Guideline tightening over the past 12 months has made it significantly harder to qualify clients, and I doubt we have seen the last of the changes.