If you’re a typical borrower, your debt ratio will largely determine whether you’re approved for a mortgage.
For applicants pushing the boundaries of qualification, these approvals have been more difficult to obtain. This is a direct result of the tightening of mortgage rules last year, which imposed more stringent calculations of the debt-to-equity ratio (among other things).
And by the end of the year, those calculations will become even more conservative.
On June 27, CMHC released new guidelines for calculating debt ratios and confirming income documents.
“In current practice, CMHC stipulates standard formulas for calculating debt service ratios, but has not specified how each the key input must be addressed, ”said CMHC spokesperson Charles Sauriol.
These new guidelines will clarify that, and will come into effect on CMHC-insured mortgages on December 31, 2013. (In practice, many lenders already apply them.)
These standards will apply to all insured residential mortgages of 1 to 4 units, regardless of the loan-to-value ratio. Uninsured (conventional) mortgages are allowed in different policies, but most lenders will use the same rules for all of their approvals.
Here are some of the new “clarifications” regarding CMHC insured mortgages:
- For variable income: Lenders should use “an amount not exceeding the average income for the past two years”. The variable refers to things like bonuses, tips, seasonal jobs, and investment income.
- For rental income: If a borrower owns other rental properties not occupied by the owner, the principal, interest, property taxes and heating (PITH) on these properties must be:
- deducted from gross rental income to establish net rental income; or
- included in “other debt securities” when calculating the total debt service ratio (TDS).
- For the income of the guarantor: A guarantor’s income should not be used in GDS / TDS ratios “unless the guarantor… occupies the home and is the borrower’s spouse or common-law partner”.
- Unsecured lines of credit and credit cards: For these debts, “Not less than 3% of the outstanding balance” should be included in the monthly debt payments. Interest-only payments are no longer taken into account on lines of credit. Additionally, lenders should assess the borrower’s credit history and borrowing behavior when determining the amount of revolving credit that should be factored into debt ratios.
- Guaranteed lines of credit: Lenders should consider “the equivalent” of a payment based on “the unpaid balance amortized over 25 years”. This payment must use the contract rate (from the LOC) or the 5-year benchmark rate (V121764) published by the Bank of Canada (if the contract rate is unknown). Again, interest-only payments are no longer allowed for the purposes of calculating the debt-to-equity ratio.
- Heating costs: Lenders are now required to obtain “actual heating cost statements” for a property. When such a history is not available, the heating expenses used in the debt-to-equity ratio calculations “should be a reasonable estimate taking into consideration factors such as property size, location and / or location. type of heating system ”. This is why some lenders have now switched to a fixed heating cost formula, like: (square foot x $ 0.75) / 12 months
Compared to previous methods (which involved fixed heating costs, like $ 100 / month), the new guidelines can double or triple the heating costs that must be factored into debt ratios on large properties and properties. reduce on the smaller ones.
It is important to reiterate that most of these policies are already followed by most lenders. But there are exceptions.
These exceptional lenders are generally seen as go-to sources when borrowers have tight debt ratios. These new guidelines are designed to minimize these “loopholes”.
This all happened, in part, because of the changes to the Ottawa rules last July. At that time, the government set the maximum gross debt service and total debt service ratios for insured mortgages at 39% and 44% respectively.
Sauriol says the change “reinforces the importance for CMHC of ensuring that debt service ratios provide the same measure of a particular borrower’s ability to service mortgage debt, regardless of the lender who submits the insurance application to CMHC ”.
Rob McLister, CMT