Yesterday, new mortgage rules went into effect that are intended to influence the housing market.

The most significant of these, at least for purposes of rent to own programs, is that borrowers now need to qualify for a mortgage at both the negotiated rate with the lenders and also at the posted Bank of Canada five-year fixed mortgage rate.

The rules apply to all “insured” mortgages, i.e., all mortgages with less than 20% down.

The move was supposedly aimed at protecting consumers from getting into trouble by getting mortgages that they can no longer afford if the interest rate rises. The spin-off effect, which seems to be the primary reason behind the move, is to dampen escalating housing prices in Vancouver and Toronto.

That, at least, would explain the timing of the move (though, as usual, the government is a little late to the table; house price inflation has already stalled in Vancouver.) But rising interest rates? Unlikely in the near future.

What this means

The bottom line is that consumers will not be able to afford as high a value of a home as they could before. They will have to settle for less.

Here’s how it works. Other government rules already limit the proportion of one’s gross monthly income that can be used for “housing costs” (known as “gross debt service ratio”). Housing costs are the total of mortgage principle and interest payments, property taxes and heat. If you are in a strata unit, a portion of the strata fee is also included. Officially, the “gross debt service ratio” cannot exceed 39% of your monthly income.

If you have to qualify for a higher interest rate than the one you have negotiated for your mortgage, then the interest portion of total housing costs will obviously be greater. You will reach your 39% limit with a smaller mortgage than what you would qualify for at a lower rate. Unless you can make up the difference with a higher down payment, the smaller mortgage you qualify for means you also only qualify a lower valued home.

Let’s look at an example

Let’s say you have an annual income of $90,000, or $7500 per month (before taxes and other deductions). Using the prescribed ratios, that means you can afford a housing cost of $2925 per month ($7500 x .39). Let’s say your taxes for the potential home purchase are $300 per month and your heat bill is $100 per month. What you’re left with, for a maximum principle and interest mortgage payment is $2525 per month.

Typically, depending on a whole range of issues, including your credit worthiness, mortgages can currently be obtained in the 2.5% – 2.99% range. Let’s use 2.75% for our example. Checking out mortgage calculation tables, this works out to a maximum mortgage amount of $548,000, i.e., the payment on a $548,000 mortgage at 2.75% is $2525. If you have 10% down, then the maximum home value you could afford is $608, 900 ($608,900 x .9 = $548,000).

With the new rules, you also have to qualify at the “posted five-year fixed rate.” That rate currently is 4.64%. Checking the mortgage tables with a 4.64% rate instead of a 2.75% rate indicates that you will reach your $2525 maximum mortgage payment at a mortgage of $450,000. This means the maximum home you can afford, with 10% down, is $500,000. That’s a drop of almost 20% from before ($608,900-$500,000 = 108,900; 108,900/608,900 = 17.9%).

How this affects rent 2 own

While the difference is substantial, we have always qualified our clients conservatively, to provide a cushion for such situations as rising interest rates. Using our standard formula, that $90,000 annual income would have qualified you for a $430,000 mortgage, or, with 10% down, a $478,000 property.

We have allowed enough cushion. Our current rent 2 own clients should be safe!

We didn’t know that the government would come down with such tough new policies. But we knew that if we were trying to qualify people for property values three years before they needed to qualify at the banks, we’d better build in a margin of safety for contingencies like rising interest rates. The rates haven’t risen yet, but the qualification standards now have the same effect.

Two further cautions

First, the above calculations were based on the legislated housing cost ceiling of 39% of gross monthly income. Not everyone qualifies for the full 39%; you have to be a stellar candidate to get that ratio. Less than stellar candidates may be limited to a lower amount, such as 35%. So, depending on your situation, your qualification level may be a little less than the above calculations.

Second, there is also a ceiling for “Total debt service ratio” that is 5% higher than the “Gross debt service ratio.” Total debt service is just that: all of your monthly debt obligations combined. So, if you have a car payment or credit card payment or student loan payment (or all three), and all those payments combined are more than 5% of your gross monthly income, then your housing payment ceiling will be lowered by the amount that those payments exceed 5%. So, for example, if all those other payments equal 12% of your gross monthly income, then your gross debt ratio drops from 39% to 32% (44% – 12% = 32%). Obviously, that will lower the size of mortgage for which you qualify.

I hope this has been helpful. Do not hesitate to respond to this post and hit me up with any questions you may still have. In the next blog post I will try to answer any further queries that you may have about these new rules.


Quote of the Week

The two most important days of your life are the day you are born and the day you find out why. – Mark Twain