In the past few weeks there has been an increase in real estate deals falling through because the financing subjects couldn’t be removed. This is part of the new financing landscape due to the mortgage regulation changes that took place last fall. We talked to Susan Lee, mortgage broker from Dominion Lending Centres, about what has changed and what can homebuyers do to increase their ability to qualify for a mortgage.
“The main change is the qualification criteria,” Susan explains. “Now we have to perform a ‘stress test’ as part of the mortgage application. The default insurance policy and premiums have also changed, making it more expensive to the Buyer. Even though these changes came into play in October, it is only now that we are seeing the effects as many mortgage applications are going sideways.”
So what is the stress test?
To help ensure new homeowners can afford their mortgages even when interest rates begin to rise, lenders have to “stress test” a borrower’s ability to make their mortgage payments at a higher interest rate. This requirement applies to all mortgages (including fixed-rate mortgages with terms of five years and more). A homebuyer with less than 20% down payment has to qualify at the greater interest rate of their contract mortgage rate or the Bank of Canada’s conventional five-year fixed posted rate. The Bank of Canada’s posted rate is typically higher than the contract mortgage rate, currently at 4.64%, compared to roughly 2% or so on variable rate mortgages.
For homeowners to qualify for mortgage insurance, their debt servicing ratios must be no higher than the maximum allowable levels when calculated using the greater of the contract rate and the Bank of Canada posted rate. Lenders and mortgage insurers assess two key debt-servicing ratios to determine if a homebuyer qualifies for an insured mortgage. The first is the Gross Debt Service (GDS) ratio, which is the carrying costs of the home, including the mortgage payment and taxes and heating costs, relative to the homebuyer’s income. The second is the Total Debt Service (TDS) ratio, which the carrying costs of the home and all other debt payments relative to the homebuyer’s income.
To qualify for mortgage insurance, a homebuyer must have a GDS ratio no greater than 39% and a TDS ratio no greater than 44%. Qualifying for a mortgage by applying the typically higher Bank of Canada posted rate when calculating a borrower’s GDS and TDS ratios serves as a “stress test” for homebuyers, providing new homebuyers a buffer to be able to continue servicing their debts even in a higher interest rate environment or if there is a reduction in household income.
So what can homebuyers do to avoid losing the home of their dreams due to financing issues? “Homebuyers that don’t qualify for a mortgage under these new regulations have options,” Susan explains. “One option is adding a guarantor or co-borrower, usually a family member. This might cover the 20% buying power that they lost with the ‘stress test’. Other alternatives are increasing the down payment or paying off some debt to lower their TDS.” Susan mentions the BC Government first-time homebuyers loan program announced last month as an option to increase a down payment, but is careful to note that not everybody qualifies and the terms might not be appealing to a specific situation.
“The rules may have changed, but what remains the same is the importance of doing the prequalification process up front before looking at properties to avoid having their offer falling through because of financing,” she adds.
If you have any more questions or wish to apply to the BC Home Owner Mortgage and Equity Partnership, contact Susan Lee at http://www.asksusanlee.com/ .
But what about Sellers?
When a real estate offer falls through, the Buyer is not the only affected party. So what can sellers do to protect themselves from financial subjects that can’t be removed?
- Get a large down payment: in the event that a Buyer cannot complete on their purchase, the Seller can make a claim against the deposit held in trust as well as search other damages.
- Find out what you can about the Buyer’s financial situation and how they intend to fund the purchase.
- If you are in a multiple offer situation and you are the Seller, remember that an offer excessively higher than the others may be too good to be true. Remember, if they are getting a mortgage the lender will not want to lend far more than the property is deemed worth if one of the Buyers offers is.