Sunday, October 29, 2017

Tips for mortgage qualifying under the new "B-20" rules

The chart above is from the Bank of Canada's daily digest page, which shows the interest rate that is used for qualifying for most mortgage loans through Canadian banks.  What it means is that you need enough income to pay a 4.99% mortgage, even if the bank is offering you an interest rate of 2.99.  The exception to this is for people with at least 20% down taking out a mortgage with a fixed term of at least five years.  The new B-20 rules remove this exception, and will require every mortgage loan from a Canadian federally-regulated bank to test the borrower's ability to pay an interest rate that is the greater of the contract rate plus 2% or the posted qualifying rate.

The first tip is one that has already been mentioned in some financial papers, and that is to go with a 30-year amortization instead of 25.  That change will decrease your monthly mortgage payment by about 8%.  A 35-year amortization would reduce the monthly mortgage payment even more, but it's hard to find banks that still offer 35-year amortizations.

The next suggestion I have for improving your chances to qualify for a larger mortgage will help even if the B-20 rules don't apply to you, and that's ensuring the bank is using the correct numbers to calculate your debt service ratios.  I mentioned debt service ratios (DSR) in an earlier post, and listed a few things that lenders use in their formulas.  Since the formulas tend to be complicated, lenders usually will not sit down and review the numbers they are using with borrowers.  They'll pull many of the numbers from the borrower's credit bureau file, and for other numbers they'll use standard assumptions.

For responsible borrowers that pay their bills in full every month, the most significant and incorrect assumption lenders make is that you don't pay all your credit card bills.  They assume you'll make payments of 3% per month, and they'll add that 3% to your monthly debt service costs.  That means if your last credit card statement was $5000, the lender will add $150 to your monthly debt service costs.  If your last two or three statements show the balance always paid in full, that should be enough to satisfy your lender.

Another common item that adds to debt service costs are vehicle loans.  If you have a car loan that is almost paid off, paying it off early could allow you to qualify for an additional $10,000 or more on your mortgage.  If you've co-signed on a vehicle loan for a family member, the lender will use the full loan payment amount in your DSR calculations, even if the vehicle owner always makes the payments.  If the family member can re-qualify without a co-signer (or get someone else to co-sign), then you can qualify for a larger mortgage.

If you are receiving spousal or child support, ask your lender if they include that in your income.  You'll likely need to provide them with a copy of a court order to prove not only the amount you are receiving, but also to prove that the payments are enforceable in the event your former partner stops.

The last suggestion is a general one to verify the numbers that your lender is using.  In fact, even before applying for a mortgage, I recommend checking your credit report for errors and getting them fixed.  When you do apply, verify all the assumptions the lender is making are correct.  Some lenders assume average monthly heating costs of $100-$150.  That might be reasonable for an older house in PEI heated with electric baseboard, but not for a newer energy-efficient home in Alberta where natural gas prices are close to the lowest in North America.

Sunday, October 1, 2017

The Mysteries of Rental Debt Service Calculations

In my post on residential mortgages, debt service calculations for an owner's primary residence were relatively simple to explain.  With rental properties, just trying to understand debt service calculations for can be quite perplexing.  And even if you can understand the calculations, there are quirks in the formulas that don't seem to make much sense.  At least lenders tend to use the same GDS and TDS limits for rental properties as they do for a primary residence.  For GDS that is 32-35%, and 42-44% for TDS.  Unlike the rules for CMHC-insured mortgages, these debt service limits can be exceeded depending on the overall strength of the application.

I'll start with the calculations for someone making their first rental property purchase.  BMO, CIBC, and Scotia all seem to follow CMHC's rules for calculating GDS, even though CMHC does not insure single-unit rental properties.  This means that to calculate Gross Debt Service ratio, half of the rental income will be added to the purchaser's income, then the principal and interest will be divided by that sum.  To calculate Total Debt Service ratio, it is necessary to add the purchaser's other debt service costs, such as primary residence mortgage payment and car loan.  In the spreadsheet above (google docs link) I've done the calculations for someone making a salary of $50,000 per year, with principal, interest, and taxes on their home of $850 per month, and no other debt service costs.  The rental property is being purchased for $200,000, and it rents for $1400 per month with all utilities paid by the tenant.  The results indicate a very low GDS of 19%, and a modest TDS of 36%.

Once more than one rental property is involved, the calculations become much more complicated.  Most lenders use a rental offset calculation for the rental properties you already own, while some (like CIBC) will use Debt Service Coverage Ratio.  Rather than explain the full details here, this Moneysense article does a good job explaining the two.  The spreadsheet above shows a second rental property mortgage for $160,000 with the same $1400 in monthly rent.  The 50% rental offset used by Scotiabank results in a slight increase in TDS from 36% to 38%.  BMO uses a more generous 85% rental offset, which results in a reduced TDS of 34%.

Finally, I'll show how the ratios change for purchasing a 2-unit rental property with a mortgage of $320,000 instead of purchasing two single-unit properties.  If you expect the ratios to be similar, you are in for a surprise.

The GDS has increased from 19% to 33%, and the TDS has gone up to 48%, well above the limits of any banks.  Unless I've made a mistake in my calculations, this means that it is much easier to get two mortgages for $160,000 than it is to get one mortgage for $320,000.  I'd expect banks to prefer one mortgage for $320,000, since processing and administering two mortgages is a lot more work for them.  I doubt lenders will change their rules for debt service calculations, since it is a lot easier for investors to purchase their properties one unit at a time than it is for a large bank to change their underwriting rules.

2017-10-02 Update: I had a conversation with a Scotiabank home financing advisor, and found out that they don't count taxes in their rental offset calculations.  That means the TDS when purchasing the 2nd rental unit would be 36% instead of 38%.

2017-11-18 Update: A TD mortgage advisor recently informed me that they, like CIBC, use a Debt Service Coverage Ratio.

Monday, September 18, 2017

Residential mortgages in Canada

Almost everyone who buys a house in Canada takes out a mortgage.  Most people, however, don't understand how lenders calculate how much you can borrow, and a large number of people don't even shop around for the best mortgage rate.  I'll explain in simple terms how to calculate how much you can borrow, and how to get a good rate.

Lenders use formulas to calculate debt service ratios from your housing costs and your income.  The housing costs lenders look at are your mortgage payment, your property taxes, and sometimes heating.  Lenders require the housing costs to be less than about a third of your gross (before tax) income.  With a bit more math, you can calculate how much of a mortgage you can get based on your income.  In general, that will be about four and a half times your income, or close to five times your income with some lenders if you have very good credit.  In other words, a single person making $40,000 per year would be able to borrow between $180,000 and $200,000.

Ten years ago I used to recommend people looking for a good rate on their mortgage deal with a mortgage broker.  The brokers could check with the big five banks and other lenders to find the best rates.  Now CIBC and BMO do not work with brokers, and Scotia sometimes will not offer their best deals through a broker.  Therefore I recommend going to three of the big banks when shopping for a mortgage, and try to find someone that does a lot of mortgages, since they are usually the ones who know how to get the best rates.  Also disclose the fact that you are shopping for the best rate and will be applying at one or two other banks.  If you don't tell the lender that you expect a great rate, you probably won't get it.  Ask local real estate agents, lawyers, or financially astute friends who they recommend for getting the best rates on a mortgage.  Mortgage comparison sites can be helpful too, however most of them are really advertisement sites that only show paid listings.  One site I trust is Rate Spy, which doesn't restrict its mortgage listings.

For people who are putting less than 20% down and therefore need mortgage insurance, I still recommend using the services of a good broker (although finding a good broker can be a bit difficult).  In the last couple years non-bank lenders have started offering better rates on insured mortgages because of the lower risk to the lender when mortgage is insured against default.  Many of these non-bank lenders only work through brokers, hence the need to use the services of a broker.  Brokers and credit unions are also the best option for people with below average credit that may not be able to qualify for a mortgage at the big banks.

For people who want more specific advise, I recommend applying with BMO and Scotiabank and asking for their best rate on a 2 year fixed mortgage.  Over the past year, at least where I live in Nova Scotia, they have had the best mortgage deals.  Even when TD or Royal has had lower advertised special rates, BMO or Scotia have been able to beat them.  Don't apply to just one of them, since sometimes BMO will offer rates that Scotia can't beat, and sometimes Scotia will offer rates BMO can't beat.

Monday, July 3, 2017

Be your own agent

What I'm about to write about would be considered heresy by some real estate agents, but I'm not one to just go with the flow.  When buying a house, you can save 2-3% by forgoing what is known as a buyer's agent, and dealing with the listing agent directly.  You'll probably have a smoother purchase process too.

In the US and Canada, depending on the market you live in, commissions paid to a buyer's agent are often 2-3% of the sale price.  Unscrupulous people in real estate will claim the buyer does not pay those commissions, but ultimately they do.  When working directly with a buyer, most listing (seller's) agents will discount some or all of the buyer's agent commission, which reduces the price you pay for the house.

Decades ago it was necessary to have a buyer's agent because they had access to the real estate listings.  Now most buyers find the properties they are interested in on their own, and only use an agent for viewing the property and as an intermediary in the purchase negotiation.  The listing agent is actually the best person to show the property, since they know the property from preparing the listing.  Having one less cog in the wheel also makes the process run smoother, and can even make the difference between getting the property you want and missing out.  When you have a buyer's agent, your interest in making an offer may not get communicated to the listing agent for several hours, and if another offer was accepted or countered during that time, you could loose the opportunity to purchase the house.

Some jurisdictions still allow dual agency, where one agent acts for the seller and the buyer, and collects the full commission.  So when you contact the listing agent, tell them you want to work without anyone acting as your agent.  In Nova Scotia, the legal term is that you are working as a "customer" and would sign a "buyer customer status acknowledgement".  People in the industry may try to scare you by pointing out that you don't have someone legally required to put your interests first, but you are still legally protected.  Due to both professional standards for licensed agents and laws regarding fraudulent sales, the listing agent has to tell you all the details of the property, both good and bad.

Before asking to see a property, one of the first things you should ask the listing agent is the commission "to the street", so you know how much would be going to a buyer's agent if you had one.  Then ask if they cut their commission to the seller by that amount if you don't have an agent.  I questioned five agents in my area, and three were willing to work directly with a buyer while cutting the full 2.5% commission off the purchase price.  One agent was willing to work directly with a buyer but would not confirm if they would forgo the 2.5%.  The fifth said they were not comfortable working directly with a buyer, and so would require them to have their own agent.

So while being your own agent may not be an option all the time, when you can save 2-3%, I think it is worth trying.  Good luck on your next real estate purchase!