If you’re a typical borrower, your debt ratios will largely determine if you’re approved for a mortgage.
For applicants who push the limits of qualification, those approvals have been tougher to come by. That’s a direct result of last year’s mortgage rule tightening, which imposed stricter debt ratio calculations (among other things).
And by year-end, those calculations will get even more conservative.
“Under current practice, CMHC stipulates standard formulas for calculation of debt service ratios but has not been specific as to how each key input is to be treated,” says CMHC spokesman Charles Sauriol.
These new guidelines will clarify that, and they become effective on CMHC-insured mortgages on December 31, 2013. (In practice, many lenders already apply them.)
These standards will apply to all insured 1-4 unit residential mortgages, regardless of the loan-to-value ratio. Uninsured (conventional) mortgages are allowed different policies, but most lenders will use the same rules for all their approvals.
Here are some of CMHC’s newly minted insured mortgage “clarifications”:
- For variable income: Lenders must use “an amount not exceeding the average income of the past two years.” Variable refers to things like bonuses, tips, seasonal employment and investment income.
- For rental income: If a borrower owns other non-owner occupied rental properties, the principal, interest, property taxes and heat (P.I.T.H.) on those properties must either be:
- deducted from gross rent revenue to establish net rental income; or
- included in ‘other debt obligations’ when the Total Debt Service (TDS) ratio is being calculated.
- For guarantor income: A guarantor’s income must not be used in GDS/TDS ratios “unless the guarantor…occupies the home and is the spouse or common-law partner of the borrower.”
- Unsecured credit lines & credit cards: For these debts, “No less than 3% of the outstanding balance” must be included in monthly debt payments. Interest-only payments are no longer considered on credit lines. Furthermore, lenders must assess the borrower’s credit history and borrowing behaviour when determining the amount of revolving credit that should be accounted for in debt ratios.
- Secured lines of credit: Lenders must factor in “the equivalent” of a payment that’s based on “the outstanding balance amortized over 25 years.” That payment must use the contract rate (of the LOC) or the 5-year Benchmark rate (V121764) published by Bank of Canada (if the contract rate is unknown). Again, interest-only payments are no longer allowed for debt ratio calculation purposes.
- Heating costs: Lenders must now obtain the “actual heating cost records” of a property. When no such history is available, the heat expense used in debt ratio calculations “must be a reasonable estimate taking into consideration factors such as property size, location and/or type of heating system.” That’s why some lenders have now moved to a set heating cost formula, like: (square footage x $0.75) / 12 months
Compared to past methods (which entailed flat heating costs, like $100/month), the new guidelines can double or triple the heating cost that must be factored into debt ratios on larger properties, and reduce it on smaller ones.
It’s important to repeat that most of these policies are already being followed by most lenders. But there are exceptions.
Those exception-case lenders are commonly viewed as go-to sources when borrowers have tight debt ratios. These new guidelines are designed to minimize those “loopholes.”
All of this has come about, in part, because of Ottawa’s rule changes last July. At that time, the government fixed the maximum Gross Debt Service and Total Debt Service ratios for insured mortgages at 39% and 44% respectively.
Sauriol says that change “reinforces the importance for CMHC to ensure that debt service ratios provide the same measure of a specific borrower’s ability to service the mortgage debt, regardless of the lender submitting the application to CMHC for insurance.”
Rob McLister, CMT