A quick discussion on the potential impact of the mortgage stress test in Vancouver…

The Mortgage Stress Test – can I still qualify for a mortgage?

…Transcripts from Episode 2 of Mortgagenomics Canada

February 18, 2018

Today, I want to have a quick talk about the mortgage options available to Canadian home owners and those currently looking to become home owners.  The headlines are starting to come out about banks declining mortgage deals to customers that would have (otherwise) qualified under the old rules, OR.. simply making it so extremely difficult to qualify to the point that applicants simply surrender… from a mortgage qualification standpoint, we are seeing the immediate impact of the new mortgage stress test and to top it off, there are other unannounced policies that have or are coming in to affect that the general public are not aware of (like for example, the tightening or reduction in the allowance of debt service ratios…39% used to be a pretty common standard for income to mortgage debt allowance if your credit score was above a 680 score (a common credit score threshold which many Canadians have), but now, many banks are reverting to 35% regardless of how strong your credit score is)…this is like a stress test within a stress test!  As for the impact on the real estate markets…it’s still too early to tell…but definitely not that far out.  The upcoming spring market will definitely give us some insight.

What exactly is the mortgage stress test?

So, If you’re currently in the process of purchasing a home or refinancing your existing mortgage, you will understand the impact of these recently implemented rules, first hand.  Everyone by now is aware that generally speaking, mortgages are much tougher to qualify for…to recap, to qualify for a mortgage today you have to qualify based on a rate that is 2% higher than what your actual rate is…and the unfortunate summary here is that you are basically qualifying for way less mortgage…as much as 30% lower than what you would have expected back in 2017. 

Does Canada really need a mortgage stress test?

So its pretty crazy, this whole stress test thing…mortgage approvals these days are totally over-qualified…like if you qualify today, every possible what-if scenario is covered by the lender.  The lenders and Canada’s governing finance arm have succeeded in protecting Canadians from themselves…that’s right, the government of Canada thinks the you, your neighbour and anyone else planning to purchase or refinance a home has absolutely no self control when it comes to handling personal finances, in particular, mortgages.  I think they are partially right and just in their approach, but they’ve chosen the lesser of two evils to focus on…and that being mortgages (a loan secured with collateral) versus what they should have went after, unsecured loans secured against absolutely no collateral (like credit cards and personal lines of credit).  So in a way, the new stress test is kinda like an ultra disciplinary kind of approach to improving (let’s say) our nations financial health and this is absolutely a good thing…but on the other side of the argument you might say its killing a lot of dreams of owing a home, upgrading to a larger one to accommodate for a growing household, and maybe creating an even bigger barrier to those who were planning a purchase (at least in Vancouver and Toronto).  I don’t think this is the case in Calgary and Edmonton though (or maybe I should re-phrase, it’s not as huge an impact in Calgary and Edmonton (and most other Canadian cities) as it is in Vancouver…and Toronto).

…it’s all relative

For example, the purchasing power has been slashed for all Canadians, but the variation in the price appreciation of real estate across Canada is quite drastic.  For the past 5 years, the price appreciation has been negligible in Calgary whereas in Vancouver it was so significant that it resulted in one of two classifications;  You were either a newly declared millionaire as a result of your property, or a newly declared long-term (maybe lifetime) renter with dreams of one day owning a home in Vancouver…I left Calgary in 2011 and my home was worth about $490/$500k…last week, I sold it for $515,000.  Meanwhile, in Vancouver, I purchased a property in 2013 for $850,000 and I can probably get some real serious offers on it right now for at least $1.5M.  I know, crazy.  But this is what Vancouver and Toronto are faced with…this situation absolutely warrants the use of the word crisis…affordability crisis.  Although It’s hard to be sympathetic to homeowners in Vancouver who have become so called “equity millionaires”, when you look deeper, the real issue is that a massively deep rooted, tax paying and employable population base has become severely demoralized at the prospect of ever owning a home in the place they were born and raised.

10 major mortgage rule changes since 2008

It’s gonna be interesting how the rental market AND the real estate market unfold in the coming months…of all the mortgage rule and policy changes in the last 10 years, I can tell you that they were all pretty drastic and impactful.  Did any single one of the changes result in a major price collapse?  That question is easy to answer if you were in Vancouver (or Toronto).  The answer would be “no”, the rule changes since 2008 have had absolutely no impact on making homes more affordable, they have not caused a softening of prices.  In fact, the market has been booming since the implementation of the first major rule change back in 2008…this was the first stress-test like rule change; reducing the maximum qualifying amortization from 40 years to 35 years…this is where the purchasing power began to diminish.  Fast forward 10 years to today…the maximum qualifying amortization is 25 years and the 2% stress test is the final nail in the coffin.

the law of supply…and DEMAND

You gotta wonder…what if the mortgage stress test, foreign buyer tax and empty home tax don’t do the trick?  What if this spring market picks up again and continues on its path?  What then?  What will the next policy change be?  All along, we’ve been tinkering with the demand side…maybe, just maybe policy makers will begin (serious) discussion and perhaps focus more on looking at the possibility of expanding, innovating or accelerating triggers on the supply side of real estate.  This is where it gets tricky though…making policy on mortgages and property taxes is driven overwhelmingly by the government of Canada, but as far as land usage, zoning or development…a much larger component of voters/existing home owners/tax-payers (you know, everyday people)…empowered to have their say on the rate and type of growth for the present and the unforeseeable future.  Of course, this is democracy.  And in a democracy, NIMBYism is a legit right…so as the debate rages on in Canada with pipeline NIMBYISM, perhaps we’ll begin to see the same with homeowners in neighbourhoods not open to densification intentions of developers and prospective home buyers.  Many say that this is already the case…the process to build more supply is so time enduring that the profit margin becomes compromised to the point that it doesn’t make sense to proceed.  Is their enough supply in Vancouver?  If not, are we willing to increase densification and better stream line our home building process?  The damage is done (the affordability issue is here to stay)…Vancouver is now a legit world renowned city that is like all world renowned cities, expensive, I think THE question that needs to be answered is…where do we go from here?

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Mortgage Qualification Deal Breakers

So in my intro, I stated that we will be talking about the mortgage options available for Canadians looking to get in to an outrageously priced market like Vancouver. Here are some of the common mortgage deal breakers for applicants in Vancouver and while I list these, I’ll (at the same time) add how to remedy them:

Before I list the deal breakers, lets introduce a few variables or entry-level thresholds…without doing intense research on price points in Vancouver, lets use an entry level price range for a condo of $500,000 (1 bedroom, hopefully at least 600 sq ft).  To qualify for this with a minimal down payment of $25,000 (5%), you would require an income of $97,000/year…good news on the income though, it could be a combined $97,000 (get your folks on the mortgage, siblings, friend…whomever), as long as it adds up to $97,000/year.   As for the downpayment, the only stipulation is that it is not from a personal line of credit or credit card (what the lender refers to as “borrowed funds”).  Parental support or what lenders refer to as a “gift” however, are totally acceptable and welcome.  And finally, I’ve accounted for an allowable monthly amount of $400 for other debt like say a car payment or some accumulated credit card debt.

OK, so deal breaker #1…

• New car loans or leases (and basically any other personal debt other than mortgages).  I would say a reasonable monthly payment for a car loan is about $400/m…but every so often I see a monthly payment that exceeds $800/month. Here’s the difference…the guy with $400/m will qualify for a purchase $500,00 with a minimum down payment of $25,000.  But the guy with an $800 car payment qualifies for a purchase of $415,000 with a minimum down payment of $20,750.  So, not quite an impact of the magnitude you would expect as the 2% stress test, but still quite a substantial loss in buying power by 17%.  So, all together…were at potentially, a 37% reduction in your buying power due to the 2% stress test AND the choice of car you purchased.  Pretty insane, hey?  I won’t do the car industry any favours when I say this, but maybe lay off or out right eliminate the temptation for a big car payment…or at least until AFTER you close on your real estate deal.

deal breaker #2…

• Self employed income declaration.  In the previous financing order, lenders used to assume (or maybe I should say, give you the benefit of the doubt) that the reason why you are declaring such a low income on your Notice of Assessment (Line 150 to be precise) is because you are a savvy business person incorporating advanced tax strategies…like keeping the cash in the business so as to take advantage of a more preferred rate of taxation.  They would then, as a result, allow you to bump up or what was better know as in the lending industry, state your income.  This allowed the applicant to significantly bump up his income on a mortgage application to a figure where they could qualify for a mortgage…as long as you were self employed for at least 2 years and had a credit score of at least 680 and had a down payment of at least 20%, you could do so…without much documentation and verification.  Well, that is no longer in force.  You can continue to declare a low income for tax purposes, but you will now have to provide a fair amount of documents pertaining to your business…if your company is successful and indeed profitable, then fear not as you will be fine as long as you are patient and forthcoming with your requested documentation.  But if your company is not profitable and your declared income is, in fact, your true be all and end all income…basically, if your declared income is low because you haven’t had a great year…you will be restricted from grossing up your income.  After reviewing your business financials, the lender will deem that your company is not profitable and there is no potential for grossing up your qualifying income.  If you currently have a salaried job and have aspirations of becoming self employed, I would definitely hold off on your entrepreneurial dream until you purchase your real estate…just remember, as soon as you become self employed you are essentially unmortgagable for a period of two years (and that’s assuming you have a stellar start to your business)…so really, you could be unmortgageable for longer than 2 years when you consider the statistic that oner 50% of businesses fail within 7 years of their start up.

And to end on a good note, I’m gonna change from deal breaker to deal saver…

• Adding a co-signor to your mortgage.  In many instances applicants fall short in qualifying for a mortgage, but really don’t realize how short.  And before we can bring up the prospect of adding a co-signer on to your mortgage application, the idea is in many cases out right dismissed for humility or fear of rejection from the potential co-signor or pride, or whatever.  But when the terms are understood, particularly the exit strategy for the co-signor, the proposition could then become more comforting and agreeable.  So, if a co-signor is suggested to you by a lender, be sure to ask how much income you are actually short for qualifying on your own.  Knowing this and communicating to your co-signor could be the deciding factor whether they vouch for you, or not.  For example, let’s say you are about $15,000 short to qualify for your mortgage or maybe your ($7,000) car loan has put you above the debt service ratios.  It might be comforting for your co-signor (which by the way is usually a parent) to know that as long as soon as you pay off your car loan in a couple of years you will technically qualify on your own at which time you would simply provide the appropriate documents to the lender to verify so, and there you have it…you no longer require a co-signor and can release their obligation from your mortgage.  Or, in many instances, especially if you are still at the growth phase of your carrier, it is reasonable to expect that your wage will increase in the near future.  So, don’t feel shame in acquiring a co-signor and if you do, simply discuss the exit strategy with your co-signor candidate to make them comfortable and relieved that there is an exit strategy.

Alright, well that’s a wrap… I hope you got value out of todays episode.  Feel free to reach out to me if you’d like to discuss anything we talked about in greater detail…or any other mortgage related matter, you can find me at markogelo.com or follow me on Facebook by searching Mortgagenomics Canada Podcast.  Also, please don’t hesitate to share and tell your friends about Mortgagenomics Canada…the more listeners the better.

Thanks again for your time, talk to you later.