New Challenges for Borrowers and Brokers Alike

Special to CMT, By Karen Beattie, NEXSYS Financial


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 zero balance. 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
    . 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.

mortgage-rules-2012The 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:

  1. 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
  2. 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.
  3. 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

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.

Karen Beattie is Business Development Manager at NEXSYS Financial Inc. Karen has been involved in the Canadian Mortgage Industry for 20
years, starting at the lender level and then working as a mortgage agent. She now specializes
in underwriting and document validation.

  1. so, with all these qualifying criteria, my questions remain: how are average people still buying high priced Toronto properties? Why does CMHC get involved in insuring high mortgages, yet they will reject extremely low priced/low region properties? Why do appraisers deliberately lower the value of a property and not abide by the true definition of appraisal? And I still say the new canadian lending restrictions stifles new growth.

  2. I’m confused. You really think this is a AAA borrower? I think that borrower is WHY they had to change the rules to tighten the restrictions. Why are they refinancing after one year? AND, why for more than what they did originally? That is major red flag to me. This is the EXACT situation where a 1.5% increase in interest rates would have the drastic affect under what you call the “old” rules. This article proves the opposite of what the author intends to argue!

  3. Yes 29/35 ratios with assets, good jobs and an 800 credit score are definitely AAA borrowers.
    If you know how to do mortgage math, compare the TDS increase of a 1.5% rate increase with the TDS increase of a 5.14% qualifying rate and $450 ULOC payment. There is no comparison. The point being made is valid.

  4. The whole point of the rule changes was to address the issue that borrowers similar to the one above do not have a real “29/35” ratio. The other option would have been to change the acceptable TDS and GDS ratios. For all the people crying about the “so harsh” rule changes — Please explain why sales continue at near all time highs and WHY prices continue to go up at an unsustainable 5% per year???? The reality is that the rules have barely had any affect besides mildly slowing a real estate market sky rocketing to a bubble.

  5. I would like to know Tony’s true definition of an apprasal. I believe, appraisers are still estimating “market value”

  6. No kidding. $640,000 mortgage at an income of only $120,000? Pure and absolute insanity.
    We have similar income and savings, and our mortgage of slightly more than half that is the max I’d be comfortable with.
    The only reason this is working at all is because of the incredibly low rates. They should have never qualified for that amount to start with and if this is considered a AAA borrower then the state of the business is much worse than I thought.

  7. Woow … so the “sample applicants” mentioned above are considered to have an enviable “AAA” rating? How can that possibly be, when these folks are right on the margins of affordability for the mortgage they have requested. By my own calculations, they are one job loss, or one pay-cut, or one misfortune, or one serious interest raise away from defaulting! These are not AAA applicants, not for that mortgage. On the other hand, these are exactly the kind of folks who make the system unstable.
    All the things listed above that lenders are now doing sound like common-sense to me. If you owe $0 balance on your 15K secure Credt line today, that could easily change to $15K tommorow, so a lender would have to be totally nuts to calculate your obligations at $0 balance. Think of it this way: if you didn’t have the line of credit, and you applied to get one AFTER you had already gotten gotten the mortgage, would your obligations be calculated at 0%?
    House prices continue to rise to unreasonable levels, and I wouldn’t comnplain about it if Canadian incomes were rising as well. But they are not. So the bubble is making housing unaffordable, both for home owners and for renters. Something is gotta give. Sooner or later.

  8. I don’t think you understand debt ratios. At 29/35 there is sufficient room for worst case scenarios even if rates jump 2-3%. Especially when the borrower has liquid assets.

  9. Um the Smiths qualify for 30 year amortization because their loan has amortized 35 years. All else equal it seems like they were trying to get a “revolving” credit by perpetually re-amortizing.
    I would have (naively) thought that declining amortization schedules is the norm, not anything new.

  10. @LS
    What a silly overreaction. If you think 29/35 ratios are high then you know nothing about mortgage underwriting. The ceiling is 39/44.
    What you personally find “comfortable” is irrelevant to the discussion.

  11. Interesting conversations. It really is illuminating what a AAA borrower is considered to be, and no one blinks an eye at a 5x income mortgage.
    I think that as over time credit conditions and price of money have loosened considerably, people, borrowers and lenders alike, have gotten used to them. Now, any restriction, no mater how minor or justified, is seen as harsh and over the top.
    In reality, Canadian households have been borrowing money hand over fist, and debt growth is on a completely unsustainable path. Around this reality has grown up a massive financial services industry, so of course any contraction will be strongly resisted. Although yards were handed out and accepted freely, every inch of pullback will be fought tooth and nail.

  12. Thanks Karen for the bog. It surely is tough to get financing for even an AAA client these days. There is always a reason for the lenders not do the financing. I wonder how tough will it get once the rates start moving up. I used to love my job but it is not as rewarding as it was ten years ago.

  13. Maybe it’s silly, but anyone with an income of only $120,000, a mortgage of $640,000, and a car loan of $500/month is not setting themselves up for financial success, and is extremely exposed to any unforseen events like job loss, divorce, rate increase, etc.
    Nevermind the red flags of refinancing so soon and increasing their debt load rather than decreasing it.
    These “AAA borrowers” are setting themselves up to be debt slaves for life.

  14. $120K is sufficient income for a $640K mortgage. It has been since GDS was raised to 32% in 1981. Nothing to see here. Move on.

  15. You don’t get the reality of this borrower’s so-called AAA credit. The borrower put down 20% down last year with a 35 year amortization because of their child in university. That probably puts the couple in their 50s. So, they are going to pay off the house when they are 85+??? They re-finance for more money prob because their house went up in “paper value”??? They only have 150K in RRSP at the age of 50+ with 15% equity of the original value of their home??? They have a car loan of 500/month and only salaries before tax of 120K (60k each)??? They obviously haven’t saved for the child’s education because they need a 35 year amortization. They are also re-financing a 5 year 2.89% mortgage for a higher interest rate??? They must be desperate for cash. ALL I see are RED FLAGS!

  16. There seems to be an underlying tone that people that have had their financial qualifying ratios changed by a mere stroke of pen are somehow poor money managers and should be denied additional credit. One of the recommendations from Financial Planners to their clients is to consolidate debt by mortgage refinancing – as one tool to manage better cash flow – to be redirected in better areas. If we are critical of individuals that cannot qualify now due to the way financial ratios are now calculated – then what is to be said with so many governments at all levels increasing their debt ? Of course government and personal finances are different – but is the criticism warranted against individuals in this day and age of rising taxation, fees, etc. Many seniors that have done things right all their lives, are heading into ” retirement ” with debt in record numbers.
    Is it okay for governments to have so much debt [ not annual deficits – talking about accumulated DEBT ] that government debt cannot be paid off in our lifetimes ? The same governments that are imposing restrictions on it’s citizens – when they themselves are in so much debt ?

  17. >> $120K is sufficient income for a $640K mortgage. It has been since GDS was raised to 32% in 1981. Nothing to see here. Move on.
    Nonsense. The only reason they can borrow that much today is because of low rates. The GDS is the same, but maxing it with today’s low rates is way riskier than maxing it 20 years ago at 8%. Not sure why you don’t understand that.

  18. Credit scoring can sometimes be a bit deceiving. I’ve seen what some would consider ‘B’ clients with a pile of debt and low scores, go out and refinance, payout their debt, wait a few months and presto, just like magic, become ‘A’ clients right before your eyes. I’ve always wondered why the GDS/TDS is based on pre tax dollars. Who lives on pre-tax dollars anyway. With the way government debt is going, it’s our kids that will suffer. #mytwocents

  19. You want to really see if these borrowers are AAA risk, simply work with their net income and work up a budget. This will confirm that these borrowers are high-risk and nowhere near a AAA rating. The TDS/GDS rules are completely outdated.

  20. I think it might be incredibly valuable for AMP designation to require each and every person qualifyng for their AMP
    for their to work in a collections department for 2 weeks. This would be an extremely educational experience , particularly for brokers who generally have little relationship with defaulted mortgagee or certainly financial skin in the game with respect the the mortgage default. When one experiences so called AAA clients losing their homes for over extending themselves and refinancing their way through life, it’s quite an eye opening gut wrenching experience. Perhaps it might be more valuable to institute this program when rates have increased by 1,5 -2% and the number of foreclosures increases dramatically.

  21. We are facing big changes that will effect every Canadian. I guess the bottom line is that the government rule changes will reduce personal mortgage debt because less people will qualify to own their own home.
    Aren’t we already known for conservative mortgage lending? Any rules changes coming regarding high interest credit card debt? Seems to me this is a much bigger problem.
    I hope Canadians with good credit, cash savings and good jobs will continue to have reasonable access to mortgage money. I hope the mono line lenders will survive!
    Unfortunately, if rules continue to get even tighter I think we are going to see a new generation of renters….we can call them ‘GEN-R’. Yikes!!

  22. You have it backwards … they were poor money managers before (when they were apparently “AAA”) — the only difference is that the rule changes (aka. the pen) now actually identifies them as such. This actually speaks to the “Canada is not the USA” argument which says Canadian banks have not given $$$ to people who didn’t qualify like they did in the States. WE in Canada have much stricter lending conditions … BUT what happens when there is a flaw in the MODEL (aka. the rules) that identifies what a so-called AAA borrower is? The answer depends on how big the flaw is OR how much the flaw in the model was manipulated. These rule changes are trying to address the “flaws” in the qualifying models and thus reduce the “model risk” of indentifying one’s true credit worthiness. For those of you paying attention, you might recall that one of the main problems at the heart of the financial crisis was that the valuation models were so limited in scope that they couldn’t link home price changes to the value of securities with mortgages as underlying collateral. In other words, the MODEL used for valuation was wrong and in a BIG way.

  23. There is no flaw with the model. The old underwriting guidelines have worked exceptionally well for over 40 years. It is no coincidence that arrears have averaged only 30-40 basis points for decades.

  24. They would be in rough shape if they had a 3% interest rate increase and refinanced under the new rules. This couple should not have a $680K mortgage.

  25. So, while rules in every other financial related industry have changed over the last 40 years but “the old underwwriting guidelines” are untouchable? Wow. Again, you are missing the whole point that this “AAA borrower” is the proof that the model is flawed. In fact, interest rates have never been this low for this long in the last 40 years of “Ye old underwriting guidelines” and that is the exact reason that the flaw in the model is obvious now.

  26. What you said does not refute the facts in my comment. You are completely wrong in your assessment of a AAA borrower.
    Regarding interest rates, rates have increased 3% before. This would not be the first time and it would not cause the calamity you imply.

  27. “This couple should not have a $680K mortgage”
    Hey Frank
    What do you base that on exactly?
    I doubt you even know how to calculate this couple’s debt service at 3% higher rates.
    Are you taking into account their other resources, loan to value, great credit, rising income and the fact that they keep paying off debt and building equity?
    Too many people here are commenting with no numbers or logic to back up their statements. There is no lender in Canada that would not want this couple as customers under normal guidelines.

  28. Harper’s goverment wants to control everything even people life. With their infinite stupid rules the economy will go down the drain, nobody will be able to buy a house. Will see then how much they are smart…

  29. 2% higher rates will not increase foreclosures dramatically. It would take a lot more than that.
    There have always been foreclosures and always will be. No amount of rules will prevent them. The policies they are imposing now will barely make a scratch in arrears rates. All they will do is keep qualified hard working people from buying homes.

  30. The rules have changed massively in 40 years. If you change the definition of a Aaa borrower, is he still a Aaa borrower?
    Things go in cycles. After credit floodgates were opened, it is now time for them to close up. And mortgages that can’t be pawned off on the CMHC are facing far greater scrutiny. Figure out how to make money in the new environment, or find a new job.
    Atefeh Shirafkan above said he used to love his job, years ago. Yeah, when everyone with a job (and many without) qualified for huge loans, and you’re the one handing out the good news, that’s a great job to have. Now you have to learn a new word: no, and be the bearer of bad news. Some people simply don’t qualify for the kind of money they believe they do.

  31. What do you base that on exactly?
    35 year mortgage, record low interest rates, interest only LOC. Let me guess, they have a 0%, 96 month car load too? They have a child who is pursuing a post secondary education means they are probably 50 years old with a 680K mortgage with a combined income of $120K? Just because they fall within the parameters that are used to determine the amount of dept they can incur for their mortgage does not mean its in their best interest to borrow a massive amount of cash that they will never be able to pay back. They have put themselves in a position where they are hyper sensitive to any type of financial or economic downturn IE: interest rate increase, job loss, RE downturn etc. This is common sense and I’m shocked that these clients are viewed as ideal.

  32. Its amusing, seeing all these commissionbrokers wailing so much, because regular people are being asked to cut their debt according to their income. When trouble hits, guess who is left holding the bucket?
    HINT: Its not the one who already collected their commisions!

  33. More amusing – pathetic actually – are people who take anonymous pot shots. Playing the commission card on brokers with bona fide concerns is old and weak.

  34. You say “Just because they fall within the parameters that are used to determine the amount of dept they can incur for their mortgage does not mean its in their best interest to borrow a massive amount of cash that they will never be able to pay back.”
    As long as this family is not a default risk, and they’re not, then your opinion of their best interest means little. TDS ratios have specific limits for a reason. As long as someone with great credit and employment falls within those limits, live and let live.
    People pay off long term mortgages in two thirds of their original amortization. So you are wrong to say they won’t pay it back.
    This couple also has assets and earning power and 25% equity so you are wrong to say they are hyper sensitive to risk.
    You’re wrong a lot Frank. In my opinion your misleading criticisms are a disservice to the people who read them.

  35. Why don’t you humour us and tell us what their budget is? You seem to know them so well.
    If you think 29/35 ratios are outdated then you are pretty much writing off 1/3 to 1/2 the borrowers in this country.

  36. The B20 rules don’t include the tightening of the unsecured credit such as many have described in their comments. I myself find that clients are always shocked at how much the bank will give them based on their income. It seems funny that the conversation is “how much do I qualify for?” when it should be “I’d be comfortable paying X per month”
    The banks that are counting this unsecured credit as debt are being prudent. I believe this practice needs to be country wide. Approving a mortgage for someone that has a LOC that isn’t being used and not factoring in payments as if the LOC is fully utilized is similar to the person in charge of the life jackets on the titanic – irresponsible.

  37. Totally disagree. LOC payments are usually interest only. There is no reason a bank has to use a 3% payment on the entire unused limit in that case. If the goal is to qualify people on realistic scenarios, then use interest only payments on the limit.

  38. It’s “realistic” to expect that people go into debt and never pay it off again? The expectations of “normal” on this thread tell quite a story indeed.

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