The use of Canada’s benchmark rate in administering the mortgage stress test is currently under review, according to an official with the Office of the Superintendent of Financial Institutions (OSFI).
Canadian Mortgage Trends – Steve Huebl·
Increasing the length of mortgage terms isn’t just about allowing consumers greater choice; it could have the added benefit of enhancing financial stability, writes Michael K. Feldman in the latest report from the C.D. Howe Institute, an independent not-for-profit research organization.
The idea of longer-term amortizations got a lot of attention in the lead-up to last fall’s federal election. PC Candidate Andrew Scheer was particularly vocal about his intent to raise amortizations for first-time homebuyers, along with various real estate boards. Lengthening mortgage terms would also have a big impact on consumers as well as the overall economy.
Feldman first waded into the conversation regarding longer-term mortgages in 2018. He has since been joined by Bank of Canada Governor Stephen Poloz, whose remarks to the Canadian Credit Union Association in 2019 noted three ways that more variety in mortgage durations would contribute to a safer financial system: if more borrowers had longer-term mortgages, they wouldn’t face the risk of having to renew at higher interest rates as often; homeowners would have the potential to build more equity within a single term, giving them more options upon renewal; and fewer borrowers would be renewing their mortgages in any given year.
Feldman adds that longer-term mortgages act as a protection in the event of systemic instability.
“A significant downturn in the real estate market could result in the insolvency of some mortgage lenders, particularly unregulated lenders. If this were to happen, borrowers from these lenders may not be able to renew their mortgages if their lenders were being liquidated and may not be able to refinance their mortgages due to the downturn in the real estate market,” Feldman writes. “This would lead to additional defaulted mortgages, which could further depress the real estate market. This risk decreases with more longer-term mortgages because there will be fewer renewals throughout the amortization term.”
There are, however, some regulatory obstacles that stand in the way of longer mortgage terms becoming commonplace in Canada, and one of those is demand.
The government would have to provide incentives to both borrowers and lenders to jump-start this demand, and/or make some regulatory changes. Feldman writes that these changes could include revising the stress-test for longer-term mortgages.
“Since the main purpose of the stress test is to predict the ability of borrowers to continue to service their mortgages if they must renew at maturity at a higher interest rate, it would be logical to loosen the stress test for borrowers willing to fix their rates for terms longer than five years. For example, if the stress test for a 10-year mortgage was set at the contract rate plus one percent (or zero percent) without any reference to a “Bank of Canada 10-year mortgage rate” (in recognition of the added refinancing flexibility after 10 years compared to five years), then borrowers could qualify for larger mortgages by opting for 10-year mortgages. This would encourage them to seek out longer-term mortgages and require lenders to offer competitive rates to retain market share.”
Other changes include amending the Interest Act to reduce the pricing premium that a lender would have to charge for its reinvestment risk on mortgages up to 10 years and reducing that risk in general by giving borrowers a short-term redemption period; increasing covered bond limits, and developing a private residential mortgage-backed securities market.
Limiting mortgages to five-year terms is thought to have grown out of a 19th-century statute that allowed the borrower to pay off the mortgage with a set penalty of no more than three months’ interest any time after five years following the initial date of the mortgage. The practice then evolved to where borrowers could renew their mortgage for another five years after the initial five-year period, with that renewal date becoming the new date of the mortgage. As long as the lender provided borrowers the opportunity to “redeem” the mortgage once every five years, they could prevent borrowers from prepaying the mortgage in full during the rest of the term without penalty.
As a result of this evolution, lenders can avoid reinvestment risks associated with prepayments by offering mortgages and renewals with terms no longer than five years, Feldman writes. From a borrower perspective, however, if there were increased desire for 10-year mortgages and increased competition from lenders to meet the demand, the cost of prepayment penalties would be reduced.
The majority of regulated financial institutions in Canada fund most of their uninsured residential mortgages by accepting deposits, including GICs that are insured by the CDIC. The CDIC, however, may only insure deposits having a term of five years or less. This limit posts a challenge for issuing longer-term mortgages from institutions that rely on these deposits.
This hurdle, however, may soon be removed. The federal government amended the CDIC Act to eliminate the five-year term limit on insured deposits, which comes into effect on April 3rd, 2020. This, Feldman believes, should make it easier for federally regulated financial institutions to fund longer-term mortgages—in theory.
“This will depend upon the retail demand for longer-term deposits,” he writes. “In a flat yield curve environment, as we have now, one would expect that most retail demand would be for shorter-term deposits; however, once the yield curve reverts to a more common rising curve, a demand for longer-term deposits may develop.”
Ultimately, Feldman writes, the current five-year term is “too well-entrenched to be overcome organically” and that the federal government will have to modify certain rules and create policies and programs in order to change the status quo.
Houses and townhouses are seen in an aerial view, in Langley, B.C., on Wednesday May 16, 2018. (Darryl Dyck/CP)
When it comes to mortgages, a government survey finds most Canadians don’t know their terms from their amortizations
It’s no secret that the financial literacy of Canadians is tenuous at best, but given the fact that households are carrying $1.6 trillion worth of residential mortgage debt, we should be particularly nervous about just how yawning the knowledge gaps are when it comes to the basics of a mortgage.
A survey conducted for the Financial Consumer Agency of Canada and the Bank of Canada and made public this week found when it comes to simple mortgage terminology like “term” and “amortization” most Canadians are hopelessly lost.
According to the survey slightly more than half of consumers failed to correctly identity what “mortgage term” means. Only 49 per cent offered purely correct responses like “the years you have a mortgage/contract term,” “the length of time you are committed to a mortgage rate,” or “the length of time before renewal.”
Canadians have an even shakier grasp on what “amortization” means — while just over one quarter (28 per cent) of the general population could offer a proper definition of the word, they also said things in their answers that made it clear they didn’t fully know what they were talking about.
Fewer than one per cent of Canadians could give a strictly correct definition for amortization as “the time to pay the mortgage in full.”
Just so we’re clear, the amortization period is the length of time it will take you to completely pay off a mortgage (generally 25 years) while the mortgage term is the length of time you commit to a specific mortgage rate and conditions with a lender (usually five years).
While the above responses from the survey reflect the mortgage knowledge of the general population, even those people specifically targeted in the survey who have a mortgage or plan to buy a home in the next five years had only a marginally-better understanding of mortgage basics. As the survey results note, “three-in-10 in the target audience … do not know what the phrase ‘amortization period’ means,” which suggests a large number of people plunged into the biggest financial decision of their lives with a dubious understanding of the core terminology in the documents they were signing.
“The responses indicate that there is a significant lack of knowledge about mortgage terms among both the general population and the target audience,” wrote the authors of the survey. The survey, which was published was conducted by Ipsos Public Affairs and involved interviews with 5,000 Canadians between May and June 2019.
The findings were meant to establish the “baseline knowledge” Canadians have about mortgages as part of a larger quest: to find out what Canadians know about long-term mortgages and why they don’t chose that option more.
In fact just as the survey was getting underway last May, Bank of Canada governor Stephen Poloz gave a speech in Winnipeg where he made an impassioned (well, for a central banker, at least) case for the financial industry and Canadians homebuyers to embrace longer-term mortgages. It was part of a broader call by him for innovation in the mortgage sector.
While fixed-rate mortgages with terms longer than five years are widely available, they’re little used — just two per cent of all mortgages issued in 2018 were fixed-rate loans with terms longer than five years, according to the Bank of Canada. Yet Poloz sees a lot of benefits to both consumers and the financial system if that number were to rise. For one thing, he said, a longer term means fewer renewals and hence less risk that when households do renew it will be at a higher rate. (Poloz acknowledged a longer-term mortgage will have a higher interest rate, but for some homebuyers the trade-off for lower risk will be worth it.)
As for the financial system, the fact that nearly half of all mortgages in Canada carry fixed-rate five-year terms means that when interest rates do start to rise again, which they will, a whole lot of borrowers who took on massive mortgages in recent years will be up for renewal each year. “Simple math tells you that of all those five-year mortgages, roughly 20 per cent will be renewed every year,” he said. “That is a lot of households. If all the mortgages were 10-year loans, only 10 per cent of these homeowners would renew every year.”
Based on the survey results Poloz has his work cut out for him — only one-in-10 homeowners or likely buyers can correctly define both a mortgage term and an amortization period and at the same time even know that mortgages with terms longer than five years exist in Canada.
Did you know that I start every single conversation with a seller with the exact same question? Probably not. I mean, how would you know?
Well, I do, and it is one of my favorite parts about real estate investing. The question I ask every seller is: “Will you do owner financing?”
Owner financing is the crown jewel of real estate (in my opinion). It affords you the ability to get into a deal a heck of a lot easier and much faster.
Put simply, owner financing is when the owner of a property sells it to a buyer but acts as the lender and holds a “note” against it. Instead of paying a normal bank every month, the buyer pays the original seller every month. Going into the agreement, the seller and buyer have an agreed upon payment amount and term length, just like a buyer would with a regular bank.
Owner financing terms are normally much shorter than your standard 15- or 30-year bank mortgage. Before the agreed upon term expires, the buyer must pay off the seller with a lump sum payment, which is typically obtained through a refinance with a regular bank.
Well, what is probably the worst thing about real estate investing? I would say it is the process of acquiring a mortgage from a regular bank lender. They want your left leg and your first-born child. Or, put dryly, they want 90 days of bank statements for all your accounts, your last two years of tax returns, a personal financial statement, and your credit score. Throughout the process of gather all of this, they’ll send 43 emails, leave 31 voicemails, and ask you to sign 27 or so different forms.
With owner financing, you effectively avoid almost all of this. Mr. or Mrs. Seller, more than likely, will not run your credit and pour over your personal and financial affairs. In my experience, the most a seller is looking for is that you are a trustworthy person and do, in fact, have the ability to pull money out of your own account or get it from someone or something else in order to provide the down payment (if required) and the monthly payments.
Please do note that while Mr. or Mrs. Seller may be more relaxed with the underwriting, you do absolutely want to be sure that you can pull this off. It does not do anyone any good to tie up a seller and then not be able to execute. The seller will normally have the power to foreclose on you just like a bank would if you start missing payments (via the governing agreement for the transaction).
You can close the deal quickly. Once you have agreed on a price and terms and the governing contract has been looked over by your attorney, you are effectively a brand new owner of a property.
Ah yes, the dreaded down payment. Mr. or Mrs. Seller, in most cases, will not hold you to the normal 20 or 25 percent down that most banks want. Most likely, he or she will not be calculating your debt-to-income ratio as it relates to your down payment and the effect it has on your monthly obligations.
Is this not what most people struggle with when buying with traditional financing? Instead, with owner financing, all of the terms are up to the buyer and the seller. You determine what is required to be handed over up front, if anything. Maybe the seller really wants a used Prius, so they require $10,000 down. Maybe he or she has $7,800 in credit card debt that they’re looking to get rid of.
With owner financing, it is important to figure out the seller’s motivation. From there, you can start to craft the terms of the deal.
Here is some bonus information about down payments: If you want to borrow the down payment, go for it. Can you do with a bank? Maybe. But when I have tried in the past, I was shut down. When I did it with an owner-financed deal, nobody even blinked.
In addition, you have complete free range to negotiate the interest rate. On one of my first deals, I had a 10 percent interest rate—not my best negotiation. But for my second owner-financed deal, I was at 5 percent. Getting better!
I found an off-market deal in Connecticut. The market was smoking hot in this particular area and I knew the town like the back of my hand. I knew he was asking about $50,000 too little. I jumped on it.
Come to find out, he did have a personal loan or two that were really bothering him. The total of those loans was about $22,500. That amount ended up being the down payment. The agreed upon purchase price was $170,000. That is 13.2 percent down a far cry from the 25 percent down banks want.
It took 30 days to close. That did run a little bit long. It was due to our attorneys going back and forth with all the legalese. But I suppose it is important to make sure the contract is done right and is fair to both parties.
If you are looking for another way to get into the game without losing the shirt on your back or the girth of your wallet, take a close look at this strategy. Ask the same first questions of sellers that I ask. What is the worst that can happen?
After you file a consumer proposal, the last thing on your mind might be a new mortgage, but you may be a lot closer than you think.
Maybe you wish to buy a home, or you own a home and are interested in refinancing your mortgage. Let’s first talk about purchasing a home.
Actually, this question comes up often. People want to know how soon can they buy. Sometimes they ask right after they file their consumer proposal, and other times it’s more than five years later, after they’ve paid it off in full.
First things first: pay off your consumer proposal completely before you take on major new mortgage debt.
If you have at least a 20% down payment, you may even be able to buy as soon as you complete your consumer proposal! As in, immediately.
You will almost always be working with either a B-lender or a private lender, but it is doable. But it’s more than just a matter of having finished your consumer proposal. Make sure you have been rebuilding your personal credit history—with new credit facilities and by cleaning up reporting errors. (There are ALWAYS reporting errors after you file a consumer proposal)
If you have less than 20% down payment, you will be looking for a high-ratio mortgage, which has default insurance, from one of CMHC, Genworth or Canada Guaranty.
In that case, you will need at least two years of clean, new credit since you completed your consumer proposal. But it’s best if you have at least two tradelines (credit card, loan, line of credit, etc.) with limits greater than $2,000.
Worst case scenario, three years after you completed your proposal, or six years after you filed your proposal (whichever comes first) it will fall off your credit report and whether or not you qualify for a mortgage to purchase a home will depend on the usual mortgage qualification criteria we all face.
This, too, can happen very quickly—in fact, we have helped numerous homeowners refinance their homes so they could complete their consumer proposal early. In some cases, it was as soon as the terms of their proposal were ratified in court.
This is what we call a lump-sum consumer proposal, and can be a very attractive way to settle your debts if you are a homeowner.
Actually, there are a few private lenders who will allow you to leave your proposal unpaid while you extract equity from your home. But unless there are specific, logical reasons to doing this, it’s not something I recommend.
I prefer refinancing to completely pay off the remaining balance owing on the consumer proposal. There may also be other things you need money for at the same time—like a home improvement project or a child’s higher education, or other family debts.
CRA debt crops up quite a lot too, particularly for those who are self-employed. You can take care of all these at the same time, provided you pay off the consumer proposal.
1) Fear of the mortgage renewal. This concern is very real if your mortgage lender had a credit card or loan product included in your consumer proposal. They might have no interest in offering you a renewal when your current mortgage matures. So, you need to get in front of this issue as soon as you can, if your situation allows for it.
2) A strong desire to rebuild your personal credit history. Once you file your CP, your credit score is going to take a major beating. All debts included in the proposal will be reporting as R7s on your personal credit report.
Worse than that, some of them will be erroneously reporting as R9s—written off completely.
And some credit cards may say they were included in a bankruptcy, even though that is not true.
A few credit cards even report ongoing late payments after the proposal was filed. And sometimes even after the proposal is completed!
If you want to fix the damage to your personal credit report resulting from your consumer proposal, you are going to have to wait until it is paid in full and you have a completion certificate from your trustee. Here is additional information on rebuilding credit after a consumer proposal.
3) Wish to be normal. When you have bad credit, everything in life seems tougher and more expensive. Even if you wish to rent a home, not buy one, the landlord will usually ask for a copy of your credit report.
And if you want a new smartphone, or lease or finance a new car, bad credit will make all this that much harder.
If you allow your consumer proposal to run the full five years, that means it could be in your credit history six years altogether. It falls off three years after you complete, so keep that in mind. You can significantly shorten the waiting time by paying the consumer proposal off early.
4) Improve cash flow. In nearly all cases when we refinance a home where the owner is paying off a consumer proposal, they see an improvement in their monthly cash outflows. In a society where half of us are living paycheque to paycheque, this is attractive.
First, your mortgage broker will do a thorough assessment of whether or not this is even doable. S/he will assess the marketability of your property, the amount of untapped equity, the reasons behind you filing your consumer proposal, as well as all the normal stuff lenders look at when reviewing a mortgage application.
An important consideration is your current first mortgage. Was it just renewed, or is it nearing maturity? Which lender is it with, and what might the prepayment penalty be if you were to break it and refinance to a new first mortgage with a B-lender?
Another consideration is whether or not your first mortgage is registered as a collateral charge, and if so, to what amount is it registered? We wrote about this a few months ago— it can make things difficult.
If refinancing the current mortgage makes sense, your broker will present your application and a presentation to the B-lenders most likely to entertain a file like yours. And s/he will bring back quotes for your consideration. If you choose to proceed, most of the time the entire process can be wrapped up in four to six weeks.
We actually see that happen less often than the other approach,which is to first apply for a private second mortgage.
In this scenario, the first mortgage is left intact and a new lender is found who will lend enough money to cover the proposal balance, any other debts and needs, and all the expenses associated with the mortgage.
During the term of the second mortgage (usually one year), we take the opportunity to cleanse all the reporting errors from the credit report, and also to strengthen the borrower’s credit profile with new healthy credit.
After a year, (longer if that makes sense) we then refinance the two mortgages into a single first mortgage.
It would be normal to expect this new replacement mortgage to be with a B-lender, since the consumer proposal is still fairly fresh. Here are some insights into how to do this.
Ultimately, the goal is to take the homeowners back to the world of A-lenders. That is usually possible after three years, but we have seen instances where it happened much sooner.
But it was never going to happen if the clients didn’t first make the decision to pay off the consumer proposal ahead of schedule.
Many Canadians might want to start their homebuying journey by contacting a realtor and scoping out open houses, but their first step should actually start in a lender’s office. The mission: To get a mortgage pre-approval. In this process, a potential mortgage lender looks at your finances to figure out the maximum amount they can lend you and what interest rates are available to you.
Lisa Okun, a Toronto-based mortgage broker, recommends getting a pre-approval right out of the gates. “You need to understand the financing piece before you start shopping. Through the process of getting a pre-approval letter, you will also get your ducks in a row,” says Okun.
The key benefits to getting a pre-approval are that you’ll have a ballpark figure for the maximum mortgage you can qualify for and your lender can estimate your monthly mortgage payments. You’ll also be able to lock in an interest rate for up to 120 days. This means if interest rates go up in the months following your pre-approval, most lenders will honour the lower rate that they initially qualified you for.
That said, pre-approvals have some limitations. Okun breaks it all down here.
Mortgages are available from several types of lenders like banks, mortgage companies and credit unions. If you’re getting a traditional mortgage, you can get pre-approved by one of Canada’s major banks or through a mortgage broker or agent. A bank will only be able to offer you mortgage products under their umbrella. Mortgage brokers and agents don’t actually lend the money directly to you. Instead, they arrange the transactions by finding a lender for you and then get a commission from the sale. Unlike a bank, brokers and agents have access to dozens of mortgage products.
Not all mortgage brokers have access to the same products, so it’s important to shop around, do your research, and compare interest rates and products before you settle on ‘the one’. Even half a percentage point can make a massive difference in the size of your monthly payments and the total interest you’ll pay over the life of your mortgage.
With a pre-approval, your lender is approving you. With a final approval, they will be approving the property you intend to buy, along with ensuring your finances haven’t changed since you were initially given the green light.
“A lender is always going to reserve the right to approve you on a live transaction,” says Okun. “Let’s say someone’s credit score dropped in the six months that they were shopping. That could change things. Now, I may have to assess you at a lower debt servicing ratio.”
In addition to the possibility of your financial snapshot changing, the lender may not like the property you want to buy (remember, as the primary investor, it’s their house too). “If they believe they would have trouble unloading that property in the event of a default, they may not go for it,” says Okun. “For condos, many have minimum square footage requirements. If there’s an environmental issue, they may have concerns about that. Or if they decide that you overpaid for it, they might only be willing to finance the property to a certain amount. Then it’s up to the client to decide if they want to come up with the difference, or if they want to walk away from that property.”
Whether you go to a bank,mortgage broker or agent, you will need to provide documentation that shows your current assets (whether it’s a car, a cottage, stocks, etc.), your income and employment status, and what percentage of your income will go towards paying your total debts.
Your lender or broker may ask you to provide a current pay stub or letter from your employer stating your title, salary, whether you’re a full-time or part-time employee, and how long you’ve been with the organization.
If you’re self-employed, your lender will need to see your taxes from the last two years (Notices of Assessment from the Canada Revenue Agency). “Ideally, it’s going to show two years of working at the same business,” says Okun. “If you had one venture and then you abandoned it and you started something new, that’s not going to show as well as if you’ve had the business for three years and your income has steadily increased.”
If you are currently employed, this is not the best time to switch up your resume. “If someone is full-time employed and they just started in a new job, I can still use a job letter and paystub,” says Okun. “But ideally, I want it to say they’re not on probation. Not to say that would kill it but it’s a bit easier if they aren’t.”
If you’ve recently switched jobs, your lender may ask to see your tax returns from previous years to confirm that you’ve had continuous employment and have stayed within a relative income bracket.
Your lender will want to have an understanding of how liquid your downpayment is. “I usually don’t ask for a history of the funds when we’re discussing pre-approval, but I will ask a lot of questions about where the funds are and how accessible they are,” says Okun. This could include details on whether you’re waiting for an inheritance or gifted funds, selling stocks or other investments, or corralling funds spread across multiple accounts.
Your lender should also have a conversation with you about closing costs, moving costs and ongoing maintenance costs to ensure you’re prepared for the total cost of owning the house you’re approved for.
Before you meet with a lender to get a pre-approval, order a copy of your credit report and review it for any errors.
If you don’t have a good credit score, the mortgage lender may refuse to approve your mortgage, decide to approve it for a lower amount or at a higher interest rate, only consider your application if you have a large downpayment, or require that someone co-sign with you on the mortgage.
Your credit score will also have an impact on how much mortgage you qualify for. Lenders figure this out by looking at what percentage of your income will go towards your housing costs and total debts (including housing). If your credit score is higher, you are allocated the maximum percentage allowance, which means you get more house for your money. “If your credit score is above 680, the limit for your gross debt service ratio (GDS) is 39 percent and total debt service ratio (TDS) is 44 percent,” says Okun. More on that below.
Your gross debt service (GDS) ratio encompasses your monthly mortgage payments, property tax, heating and 50 percent of condo fees (if applicable). This is sometimes referred to as PITH (Principal, Interest, Taxes and Heating).
Your lender will also do a calculation called total debt service ratio (TDS) that determines what percentage of your income is going towards servicing your total debts (including the housing debts you’ll be taking on).
To calculate your TDS, add up PITH and every other debt you have including car loans, credit cards, lines of credit, student loans, etc. Then see how that stacks up against your income.
The guidelines state your GDS should be no more than 32 percent and your TDS should be no more than 40 percent. However, as mentioned above, if you have a fabulous credit score you can stretch this maximum to 39 percent for GDS and 44 percent for TDS.
You might be wondering how your lender can calculate your property taxes when there isn’t a property in question. To do this they set aside one percent of the forecasted purchase price. On a $600,000 property, this amount would work out to $6,000 a year. “It’s not going to be that much but that’s the calculation your lender will use,” says Okun. That’s why it’s a good idea to run the numbers with your lenders every time you find a property of interest so they reflect your actual affordability.
Maybe your affordability isn’t reaching as high as you’d like. In this case, there are a few levers you can pull. One option is to go with a “B lender” — an institution that offers a lower barrier to entry to qualify for their products. The only problem is that this can often be offset with higher interest rates and fees.
“There are B lenders that would have different debt servicing ratios, and will let us push those numbers a little bit further,” says Okun. “But you’re going to pay a higher interest rate and there’s going to be a one percent fee to do your deal with them.” Say your mortgage is $800,000. Prepare to be dinged at least $8,000. And it’s not just a one-time fee — if you have to renew, they’ll ding you again.
“There’s always a solution, but you have to ask yourself, ‘Is it worth it and how much is it going to cost?’” says Okun.
Another suggestion Okun shares is to add a cosigner. With an extra income, you’ll have access to a higher purchasing price. “You’re also going to be taking that person’s liabilities onto the application now, so they have to be a good applicant in terms of their debt,” she says.
You could also contribute more to your downpayment to ensure you’re putting down at least 20 percent. This will give you access to a 30-year amortization, instead of a 25-year (this is the amount of time you’re given to pay your mortgage back in full). “This stretches your loan over 30 years instead of 25 which changes the payment significantly,” says Okun. “That allows you to essentially afford more.” Another strategy is to pay off significant debts so they aren’t tipping your debt servicing ratios over the edge.
Where there’s a will (and a patient lender), there is often a way.
Source: Livabl.com – Jenny Morris