“Small” Oversight

Mortgage-Qualifying-Rate-OversightThe Finance Department’s new qualification rate policy is generating no shortage of confusion.

We talked to some high level folks at the insurers and not even they know what interest rate will be used to qualify borrowers come April 19.

It could be the 5-year posted rate or the 5-year discount rate.  One source told us it might even be an offset from prime (like prime + 2%).

If it’s the 5-year discount rate (about 3.89% today) then you’d need to make at least $52,400 to qualify for a $250,000 mortgage.*

If it’s the 5-year posted rate (5.39% today) then you’d need income of $58,600 to qualify for that same mortgage…$6,200 more than if the discounted 5-year rate was used!

  *  Assumes a 35 year amortization, $500 a month in non-housing debt, 1% for property tax, $125 a month for heat, and a 680+ credit score.

With a rule change this big, wouldn’t (shouldn’t) the government have realized that lenders use different 5-year fixed rates? 

The RBCs, BMOs, and TDs of the world have posted rates. But, the INGs, Street Capitals, and First Nationals of the world, don’t.

We hate to say it, but these rules seem to have been rushed out with insufficient industry consultation–especially with respect to the game-changing new rental policies (which we’ll talk more about shortly).


Sidebar:  We’ll update new Finance Department developments as we hear about them in CMT’s Twitter mortgage news feed.

  1. I would like to hope that ideally the government will leave the choice of which 5 year rate to use (discount or posted)to the discretion of the lending institution…Do you suppose that would be wishful thinking?

  2. The REAL problem. Funny the Big Banks should be trying to influence Mortgage Market Rules to their benefit, when the REAL underlying concern is Consumer overall debt load (read: PERSONAL non-secured debt, Credit Cards, Lines of Credit, Investment Loans, Store credit, Car Loans, in other words, EVERYTHING but mortgages) ALL of which come at much higher rates than mortgages and are being carried at record levels, tightening debt service requirements on the mortgage is NOT going to do anything on the personal credit side, now, here is the BEST PART, it is ONLY the BIG FIVE BANKS that are to blame for this, and they are the only ones to issue these in abundance and have the overall exposure in the marketplace, BUT they choose to focus on the MORTGAGE MARKET? Hmmmm, something very wrong here! Simple examples, CIBC issues a credit card at 19.99%(#1 product), incentivises purchases with points and doles out $30,000 limits all day long, someone making minimum payments on that card will take 33 years to pay it off (LONGER than the mortgage amortization they are requesting!), second, ask any car dealer who they are using to finance purchases nowadays and you will find out it is magically the big five banks who have filled the void that car manufacturers used to (since they are now bankrupt don’t forget), this is classic, someone wants a new car $40,000, but they owe more on the trade than they can get for it, no problem the dealer says, we will add the $10,000 onto the price, buyer has no additional down payment, that’s OK, we can put the price up slightly to account for the ‘equity’, you have paid $55,000 for a car, financed $50,000 of it, and then as soon as you cross the parking lot line it DEPRECIATES 30%! The $40k car is now worth $28k and you owe $50k on it, therefore upside down $22k as soon as you leave the lot! The banks are fighting for this business! Now let’s see where the issue is….I challenge ANYONE to show me stats on mortgage defaults vs. Personal Bankruptcies due to high vehicle payment, job loss, credit cards, PLCs, divorce, medical issues etc. The Mortgage Market? C’mon!

  3. Absolutely agree with your ‘oversight’ analysis. As a matter of fact, the entire “rushed” release of new rules has created so much confusion amongst clients – people now think they can’t BUY with 5% down (as opposed to refi). Why not go back to using 3 year posted as some lenders already do?

  4. The qualification rate should be the fully discounted rate – since the 5 year qualifying rate is used to ensure that the borrower can make a higher payment when Prime goes up, OR if they exercise their right to lock in… well they would be locking in to the discounted 5 year in that case, therefore that should be the qualifying rate. If they are locking in to a posted 5 year then they are simply being cheated and taken advantage of by the bank.
    All of that is a minor consideration in the grand scheme of things, but I would say SHB hit the nail on the head in the above post – consumer debt is the major issue in a household, it is unsecured (for the most part, and if secured by a vehicle then usually upside down anyway) and very expensive, as opposed to the much cheaper secured mortgage which is tied to where the borrowers live – their home – not something anyone lets go of easily, as opposed to defaulting on their credit card and personal loan payments – often money borrowed for intangible expenditures which are long forgotten. These are the debts that are all too easily granted by the big banks, not mortgages…

  5. @ SHB: isn’t that why credit scores and debt service ratios are a part of mortgage approvals?
    Also – are you suggesting that people don’t use HELOCs for those same purchases?

  6. @ T.O. Resident: I agree 100%, credit scores and debt service ratios ARE an integral component in the mortgage approval process, achieved by full documentation and verification underwriting steps. The same measures are often not employed in Credit Card or Car Loan approval process for example. I did not mention HELOCs (a secured collateral charge mortgage instrument), I am sure a number of people do use them for consumer purposes (not my recommendation), but in defence of the HELOC, they can often be favourable since the rates are lower and they are limited to a maximum of 80% LTV. I am not questioning the mortgage underwriting process, but rather pointing out the underlying problem of consumer driven debt, that is provided primarily by the Big Five on an unsecured basis.
    This leads into another topic altogether surrounding the proposed down-payment requirement changes that the Big Five were/are pushing for. A great way for the Big Five to claim back market share lost to mortgage specific lenders (interestingly enough, the lenders who provide the competition to them by way of lower interest rates, benefiting the consumer, and do not offer consumer credit products), a larger down payment requirement will prevent a number of qualified people (those with excellent credit and low debt service ratios as you had noted) from purchasing a home, if this were to take place, I would be willing to bet that the Big Five will find ways to LEND the down payment with an unsecured consumer product, again, to “those that qualify”, which would ultimately be more costly to the consumer and counter to what their proposed move is intended to do. When you bring in record profits, you have deep pockets for lobbying efforts…

  7. Thanks for the excellent coverage of this issue.
    All this confusion reminds me how silly it is to expect bureaucrats to set mortgage rules for higher-than 80% LTV mortgages. They simply don’t have the expertise.
    In Australia, banks are free to set their own rules on greater-than 80% mortgages. When the Aussie banks tightened requirements last fall, there was nowhere near this level of confusion. That’s because bankers understand the banking business, bureaucrats don’t.

  8. JP Koning, in the theme of your comments I would suggest that the government should exit the business of insuring mortgages. Would you agree?

  9. In defence of bureaucrats, *all* decisions of this magnitude are absolutely OK’d by elected officials (politicians), and many policy changes of this sort are not “bottom up” decisions that are put forward by the bureaucracy after careful analysis, but rather “top down” decisions made by political masters. In other words, “we feel this is a problem. Give us some options, bureaucrats, and quick!”
    When given time to do proper consultations, bureaucrats usually put together solid policy advice. It’s not always taken, but that’s the prerogative of elected officials. I would remind people that our banking system is held up as an international model, and that’s at least partially the result of solid regulation.
    Full disclosure: I’m a public servant, albeit one that has no knowledge of the specific genesis of this policy change.
    Al R

  10. That is a ridiculous comment IMO.
    Without CMHC support of the market through insurance, MBS, CMB etc., Canadian real estate could very well have crashed one year ago.
    That would have seriously hurt millions of Canadians for no good reason.

  11. Yes, and why didn’t we have a government organization to buy Nortel stock back in 2001 to prevent it from crashing and hurting all those investors who chose to buy it? In fact, why not just ban all falling prices for anything… those pesky bear markets!
    Without CMHC support, maybe markets would have fallen. But it was because of the CMHC that they were so high to begin with! It’s like trying to fix something with the flawed tool that caused the initial screw up.

  12. bravo, JP Koning.
    Jonathan – markets will always go up and down… you’re essentially arguing that the government should indefinitely prop up a market, since having it decline would “hurt people”. Isn’t that just a government-run ponzi scheme?
    I think a little “hurt” now and again to reset people’s expectations on housing helps to avoid a giant “hurt” later on. Just because someone’s housing assets (on paper) don’t hit record levels every year, that doesn’t mean they are “hurting”. If someone bought a house that they could reasonably afford, a moderate market correction won’t matter in the long run. A medium-sized correction actually helps by making the highs and lows of the market more bearable.

  13. “Without CMHC support of the market through insurance, MBS, CMB etc., Canadian real estate could very well have crashed one year ago.”
    Whitout CMHC support Canadian real estate wouldn’t be nearly as highly priced as it is now and so this worry wouldn’t exist.
    The only reason that (personal) real estate made our grandparents rich is the slow and steady escalation in available credit, mostly backed by government over decades. Since almost everyone borrows the maximum allowed an increase in credit availability typically leads to higher prices on its own.
    Take away government backed credit and we would probably be back to putting 75% down and having 5 year mortgages.
    Its not just that we are debt slaves for up to 35 years now, its that the victims actually cheer for this situation and want to protect it.

  14. Mike,
    If 70% of people have a 44% ratio, and 30% of people have a 5% ratio, then the average is 33%.
    I’m not saying that is the case. I think we can safely say it is not the case.
    But if half of people have their TDS well under control, and half don`t…well, we still have a pretty big problem, wouldn`t you say?
    Nonetheless, I agree with you that comment you quoted was indeed factually incorrect. However I view that as a little bit of melodramatic exageration, but probably pretty accurate in its intended observation.

  15. “you’re essentially arguing that the government should indefinitely prop up a market” [quote from T.O.]
    That is not what I’m saying at all.
    I happen to think that a correction would be healthy, but there is a difference between a ‘correction’ and a ‘crash.’
    In fall 2008 AAA banks were so risk-averse that they wouldn’t even lend to other billion dollar banks. If CMHC and the government had not created emergency liquidity to “prop up” the market as you put it, we might have witnessed a perfect storm of skyrocketing rates, rising unemployment, defaults, and falling home prices. That would have led to the “giant hurt” you refer to.

  16. @Dave
    People don’t have 5% TDS ratios and a small fraction of applicants (in my experience) are near the 44% max. From what I’ve seen most applications are in the mid to high 30s for total debt ratio.
    The “risky” people are those over two standard deviations above the average. That is just 5% of the population. CIBC did a study a few weeks back and found the same. I think I remember seeing that study on this website somewhere.

  17. “That is absolutely incorrect. You would do your fellow readers a service by checking your information before posting.”
    It’s intuitively obvious that most people buy the most they can. The fact that they don’t bump up against every limit simultaneously is irrelevant.
    And if they aren’t buying the most they can, then the government can safely tighten requirements significantly more from here in the interest of limiting taxpayer exposure to the CMHC.

  18. Further to other recent comments here, I’d certainly be in favour of restricting Debt Service Ratios before increasing down payments (at this time anyway). If most people are at 30-something percent for DTS then maybe 40% ought to be the new limit.

  19. ForWhom…
    This discussion is approaching silly.
    You do not fix what is not broken and risk economic implications because you “intuitively” think there is a problem.
    Bring verifiable facts to the table or refrain from polluting the debate with your disinformation.
    Case in point is your insinuation that taxpayers have undue exposure to CMHC.
    Do you know how much profit CMHC has retained for Canadian taxpayers in the last 10 years? Do you know how much cash reserves CMHC has on hand? Do you know what a 1% default rate would cost CMHC?
    No, no, and no. You don’t.
    Until you do, please deliver any anti-housing propaganda to the willing ears of a site like Garth Turners.

  20. http://www.cmhc-schl.gc.ca/en/corp/about/anrecopl/upload/2008-Annual-Report-Consolidated-Financial-Statements.pdf
    In 2008, CMHC added approx. $140B in new mortgage-backed securities. (page 121)
    Also, in 2008, CMHC took in approx. $1.5B in fees. (page 99)
    So, based on 2008, for every dollar in fees & premiums that the CMHC collected, they insured almost 100x that amount in mortgage-backed securities.
    Or, if you look at Net Income (page 99), CMHC made approx. $1.17 billion in net income in 2008… so, when you compare that against the $140B in MBS, the ratio is more like 120x.
    If you look at total equity vs. total liabilities, you get a similar view:
    At the end of 2008, CMHC had approximately $8.17B in Total Equity (page 100), and $480B in insurance… i.e. insurance liabilities are about 60 times holdings.(http://www.cmhc.ca/en/corp/nero/nero_008.cfm)
    So, put more simply, if more than 1.7% of mortgages were to default, CMHC would be broke.
    All that being said… I don’t think that people posting here are talking about those stats. They are concerned with the general practices within the mortgage market, where CMHC insures 80%-90% of new mortgages. This means that the banks can loan out 5% down / 35-year mortgages as much as they want, and they have no risk whatsoever. This has resulted in more and more people qualifying for high LTV ratio mortgages, which enables them to bid more for houses than they would have been able to without CMHC insurance backing their loan. As the bids have gone higher, prices have increased substantially (well beyond historical averages), which has made housing less affordable for any new buyer or move-up buyer.

  21. Your stats don’t tell the true story.
    CMHC has earn billions for taxpayers in the last 10 years. If defaults ever exceeded reserves (incredibly unlikely) CMHC could temporarily borrow some of these profits back from the government.
    This is in addition to their signficant reserves which are enough to cover dramatic increases in defaults.
    This is in addition to the fact that Canadian mortgages are recourse debts (you can’t run from CMHC. They will get their money from you if you default.)
    You also need to remember that the $480 billion in insured mortgages includes bulk insurance and insured mortgages with large down payments. Default rates on those are way less than the average mortgage.
    Your post is an example of a layman making arguments based on incomplete information.

  22. D.Fielder, a question for you…
    Do you think that the presence of the CMHC has any effect on housing prices? If so, how much.
    Any others who would care to answer, please do so.

  23. @ D. Fielder:
    First, how are these “my stats”? These are directly from CMHC, not something that I made up.
    Also – CMHC insurance is only needed for mortgages with sub-20% down and/or amortizations over 25 years… so, I disagree that CMHC are “insured mortgages with large down payments”.
    CMHC’s “profits” are spent on building low-income housing… so, it’s not like these dollars are sitting in some secret bank somewhere. The numbers that they show on their annual reports ($8.17B in total equity) are it – they aren’t hiding dollars somewhere else.
    As for the concept of “temporarily borrowing some of these profits back from the government”… if CMHC needed to borrow dollars from the government to stay solvent, that means we are in a disasterous situation similar to Fannie/Freddie in the US (who have needed over $100 Billion in government dollars just to stay alive).
    You do realize that these are your tax dollars, right? Does it appropriate that possibly tens of billions of dollars would need to be spent on paying off banks for mortgages tied to properties bought at the height of a bubble? (a bubble that only exists because CMHC insures the high-leverage borrowing that drives prices higher)

  24. T.O. Resident
    I have seen you post erroneous information on this site so often that I am suprised they let you continue posting.
    CMHC also insures mortgages less than 80% loan to value.
    I really think everyone on this site would be better informed without you on it. I am not trying to be mean. I am serious.

  25. “Case in point is your insinuation that taxpayers have undue exposure to CMHC.
    Do you know how much profit CMHC has retained for Canadian taxpayers in the last 10 years? Do you know how much cash reserves CMHC has on hand? Do you know what a 1% default rate would cost CMHC?

    Until you do, please deliver any anti-housing propaganda to the willing ears of a site like Garth Turners.”
    Your helpless fury is *very* revealing.
    Let me try one more time to get this idea through to you because I’m getting very sick of salesmen pretending not to understand whats going one here:
    The CMHC makes profits because *they* flood the market with cheap money driving up the price of the assets against which they lend which in turn lowers default rates to nearly 0. For as long as they can accelerate the rate of credit growth it is IMPOSSIBLE for them to lose money.
    But once they start to cut back, prices will start to fall, default rates will go up and “chicken little” will be firmly on the hook for the losses.
    You and the other salesmen *know* this and you prove it every time you insist there is no bubble but that also there will be a catastrophe if the govt simply reverts CMHC policies to where they were in 2004.
    Debating about whether the CMHC could need a bailout is ridiculous because they already did get bailed out in the early 80s.
    Only a *tiny* percent of Americans were taking on more debt than they could handle. Only a *tiny* number of them lied on their applications. It doesn’t matter because prices are set at the margin. Responsible people have to bid against speculators and financial illiterates backed by govt subsidized credit.
    If they “win” they have decades more of debt payments than they should have had and if they lose they have to rent while they wait for the correction *and* pay for the bailouts besides.
    This ponzi scheme may go on for a while yet, but don’t think that you will be allowed to pretend that it isn’t what it is.
    The mechanisms by which we are being robbed may temporarily benefit your profession but they don’t benefit the majority of us.

  26. I work in Catastrophe Reinsurance. We made a lot of money in the decade prior to 9/11. And then in 2001 we lost 10x more that our profits from that prior decade.
    Such is the nature of insurance.
    ps. The CMHC provides insurance.

  27. Comparing other insurance companies with CMHC without talking about risk factors, underwriting guidelines, reserves, etc. is meaningless. Canadian mortgage insurers have far more conservative risk exposure than catastrophic insurers.

  28. @ Steven: please tell the visitors to this site which details from my posts are erroneous.
    Again – I simply referenced stats from the CMHC’s own site.
    Can you provide statistics for the percentage of CMHC-insured mortgages that were below 80% LTV?
    Or, were you referring to insurance against multi-unit/student/retirement properties? (aren’t those 85% LTV loans?)

  29. John,
    Insurance is insurance. Of course one needs to evaluate the variables.
    I note that you make a blanket statement in your second sentence in which you conclude the difference in the exposure.
    But I don’t see any background support for that statement….
    In point of fact, your statement is entirely incorrect.
    The premium for catastrophe reinsurance was typically less than 1/2 of 1%. Whereas the CMHC charges a premium which ranges from 0.5% to upwards of 3%.
    As such, the CMHC’s own pricing demonstrates a far higher assessment of risk.
    In the context of profitability, your statement may be true. I don’t know. Of course, we used to say the same thing 10 years ago about the business we were covering…(ah yes, ignorance was bliss!)
    Leaving aside the quibbling….
    The point I was making is that to grade the CMHC based upon the prior 10 years of profitability is no different than grading Lehman’s on its profitability in the 10 years prior to 2008.
    The issue is not whether or not the CMHC has been profitable in the prior decade. The issue is WHY has it been profitible, and WILL it continue to be so.
    I don’t have the answer. I just don’t like sloppy logic. Even on anonymous discussion boards. (nothing personal to you).
    ps. I’m an actuary, and know a little bit about insurance.

  30. T.O. resident says:@ Steven: please tell the visitors to this site which details from my posts are erroneous.
    I agree with Steven. T.O. resident, I have reviewed much of what you have had to say in recent months and this site and many of the contributors would be well served if you just found something else to do with your time.
    As for your posts, its not just that you talk down to many, it is just blantantly obvious to anyone who wastes their time reading your flawed summations or worse, responding to it as to why your posts are nearly always, ERRONEOUS and without merit.

  31. ForWhomTheTollBuilds
    You keep using fear tactics in all your posts. It doesn’t help your argument.
    Canadian default rates have never exceeded 1.02%, even when rates skyrocketed to 20% in the 80’s! The absolute worst case in Canada would be 1.0-1.5% today based on all reputable sources.
    Insurers do not flood the market with cheap money. They merely create funding cost stability. The market sets the majority of mortgage rate cost. Had CMHC not backstopped the market in late 2008/early 2009, there would have been mass panic and serious economic repercussions as the real estate demand collapsed.
    In the freak chance the government ever had to inject capital to CMHC it would easily be repaid because CMHC is a virtual monopoly, and a very profitable one. But that won’t happen because OFSI and other regulators require CMHC to stress test itself on a regular basis.
    CMHC is one of the soundest insurers in the world, bar none. To compare CMHC (and their premiums) to a normal property/casualty insurer is ridiculous without acknowledging reserves, liquidity, and actual actuarial statistics of each risk type. You also can’t compare CMHC to Lehman Brothers because CMHC’s liabilities are an open book, whereas Lehman’s were not (which led to their collapse).
    The worst part is that you don’t listen to logic. You criminalize a whole industry because you’re upset home prices are too high, or you heard somewhere that mortgages are risky, etc, etc.
    You add no value here whatsoever IMO.

  32. Hi Folks,
    Thanks to each of you for the feedback. We’re getting off topic and things are becoming a bit heated. Comments will be closed for now in this particular thread.

Comments are closed.

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