Stricter Debt Ratio Standards on the Way

debt-ratiosIf 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.

On June 27, CMHC issued new guidelines for calculating debt ratios and confirming income documents.

“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.

debt-ratios-gds-tdsHere 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

  1. Remember that time when we thought it was getting difficult? Yeah, 2011 was a difficult year. But it can’t get any worse, right?

  2. Notice how there is almost no commentary in the guidelines relating to credit scores?
    B20 rules also suggest putting less emphasis on scoring systems…OSFI & CMHC are finally waking up to the fact that in mortgage lending, credit scores, at there very best, are an insignificant tool in measuring future payment performance.
    A readily marketable property, owner’s equity, quality & quantity of income are the cornerstones of institutional & private mortgage lending.
    I truly believe that if someone were to study institutional mortgages that have gone into default, you would find that most were missing a “cornerstone”, but had “great” credit scores.
    Live long enough in this industry and every thing old is new again…now if only my ties were back in style.

  3. Once these changes take effect there will be less qualified buyers…..any predictions on how this will ultimately impact real estate values in the more expensive markets like Vancouver? Please share your thoughts.

  4. The rule changes generally effect all most monoline lenders. If the lender’s portfolio is all insured these rules come into effect for all mortgages including conventional refinance and conventional purchase.

  5. What would life be like without an annual dose of mortgage rules. Pretty soon you’ll need a government job paying $200,000 a year to get approved. At least Jim Flaherty will qualify.

  6. I live on Zeller road in Kitchener. How are the real estate values in Kitchener going to be affected by such tightening?

  7. Mortgage Servicing Department of a lender told me today that EXISTING clients porting their mortgage to a new property AND making a $20,000 prepayment on their current mortgage balance [ with excellent repayment history ] have to Fully REQUALIFY as if they are applying for a new mortgage. Wonder how many recently retired people with reduced incomes NOW would no longer qualify to port their mortgage? This seems to be trending since Flaherty’s introduction of stricter mortgage rules in the summer of 2012.

  8. The heating formula is rediculous. Costs are affected by where the home is located, the age and what improvements have been done. My new home in Vancouver would cost much less to heat than a similar size older home in Winnipeg or Montreal. Application of the same formula nation wide, with no consideration to other factors is myopic.

  9. Zeller Road will take the brunt of the tightening.
    If you lived one block over you’d be fine.
    Tough luck man.

  10. It’s important to repeat that most of these policies are already being followed by most lenders. But there are exceptions.
    If most borrowers were ALREADY following these policies then the impacts should be minimal.

  11. Or, and here is crazy idea, prices will have to come down to match what buyers can actually afford to pay…seller don’t set prices, buyers do.

  12. You’re right. It IS a crazy idea. It’s crazy because sellers do help set prices.
    People put in offers on houses all the time that are not accepted. A seller’s refusal to meet the buyer’s price in many cases forces the buyer to increase their price.
    It is more accurate to say that both buyers and sellers set prices.

  13. And those of us government employees at the bottom of the totem pole will also get to pay his salary like the rest of the Canadian tax payers. Trust me, not all of us govt job workers are living the high life and able to live stress free. What’s left after taxes isn’t a whole lot esp when it’s the only income in the household available to support two kids. Flaherty’s rules have made it impossible to get repairs done on a house or whatever if need be. Equity in house but can’t qualify to gain access to my own money! Houses up for sale like crazy around here in Halifax, and they don’t seem to be selling. He’s got everyone trapped into whatever housing situation they’re in. Renters can’t get into a mortgage & current mortgage holders can’t refinance or get out of their mortgage by selling….unless they want to forfeit any equity built up by selling at a loss. Wonder if he & the senators & Mr H stay awake at night wondering how they’re going to keep a roof over their kids’ heads AND buy groceries AND school supplies/clothes etc this month?

  14. F’s mortgage meddling only hurts people with 1/10th his salary. He couldn’t care less that working families can’t refinance anymore.

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