A new year typically means new goals and a fresh start. Going into 2018, for residential real estate investors it also means adapting to brand new mortgage qualifying rules. For some the impact of these changes is null but for others a new approach to financing and an updated action plan will be required in order to continue successfully buying real estate.
WHAT ARE THE CHANGES?
Effective January 1st, 2018, OSFI will introduce some changes that will impact
how Canadians qualify for mortgages. Among these changes the most critical is the new “stress test” criteria.
Prior to 2018 anyone who needed an uninsured mortgage (20% or more down payment), could qualify for the mortgage at the 5 year contract rate their lender was offering. Eg – If the lender was offering a 5 year Fixed rate of 3.39% then the total amount of loan you could qualify for was determined around this rate. Under the new “Stress Test”, mortgage applicants will now need to qualify at the banks 5 year contract rate + 2%. Assuming the lenders 5 year Fixed rate is 3.39% then applicants are now qualifying at 5.39% for the same uninsured loan.
IMPACTS OF THESE CHANGES
The impact to most Canadians is an estimated 20% reduction on their mortgage qualifying.
Here is a sample of the impact of the new rule changes in 2018 vs older 2017 rules:
Based on a sample of the mortgages our team closed in 2017, about 10-15% of our pool of clients WOULD NOT be able to qualify and close on their mortgage using the new 2018 qualifying criteria.
OPPORTUNITIES WITH NEW CHANGES
In my opinion with any change, opportunities can also present themselves.
One of the more obvious benefits of these new changes is less buyers who can qualify for a mortgage and purchase a primary residence. If more people can’t afford to purchase a home they’ll still need a place to live and will need to RENT. This means more DEMAND for rental housing. Certainly an opportunity for real estate investors.
With less people able to qualify for financing at higher price points then they will need to look at other markets to live. The average house in Toronto at the end of 2017 was about $825K BUT the average house just outside the GTA in the Barrie area was about $530K. Home buyers will begin to expand their home search and areas surrounding larger more expensive urban areas will likely see increased demand for housing. A great opportunity for investors who are buying in these markets.
HOW TO MITIGATE SOME OF THESE NEW CHANGES BY BEING A STRATEGIC INVESTOR
Consolidate debts and refinance
When qualifying for a loan one of the most important lender requirements is your ability to service the debt. Lenders use a GDS/TDS (gross debt service/total debt service) ratio to determine your ability to qualify. Typically, lenders like to see a GDS between 35-39% and a TDS between 42-44%. If the new rules mean an average estimated reduction in mortgage qualifying by about 20% then strategic investors need to find ways to offset this. One of the easiest ways is to consolidate debts and/or refinance your loans.
Let’s consider an example:
Isla – Annual salary of $100,000 or $8,333/mth
Personal residence mortgage payment: $2,000/mth
Personal residence home value: $700,000
Personal residence mortgage balance: $450,000
Property taxes + heat on personal residence: $500/mth
Total monthly credit debt: $950/mth (includes $47,500 in total balances)
Total monthly expenses: $3,450
= 41.4% TDS ($3,450/8,333)
To reduce her TDS ratio, Isla will either have to increase her income OR decrease her monthly expenses. At this time Isla’s income will remain the same BUT there is an opportunity to reduce her monthly credit debt payments on the $47,500.
By refinancing Isla can tap into her homes equity. Lenders will allow clients who qualify, to access up to 80% of their homes value. Assuming a value of $700K at 80% LTV, maximum loan is $560K. With an existing mortgage balance of $450K, she can access $110K of new funds. If Isla were to consolidate the $47,500 in credit debt as a small mortgage she could get her payments to an est. $210/mth assuming a 30 year amortization and a rate of 3.39%.
Isla has now reduced her credit debt by $740/mth ($950-$210) from a refinance AND likely saved hundreds in dollars in interest.
Revised TDS is now 32.5% ($2,710/$8,333). Isla is now well below 42% TDS and has given herself some additional room to qualify for future financing.
Using the above scenario for Isla as a reference, another way to improve your TDS is to reduce your monthly mortgage payment. This could be achieved by restructuring your existing mortgage.
Here is an example:
Top part of the table shows a $400K mortgage, 20 year remaining amortization and a monthly payment of $2,214.67. By re-amortizing the loan up to 30 years the new mortgage payment has been reduced by $532.26/mth to the new monthly payment of $1,682.41. This solution will assist in reducing overall expenses, reduce GDS/TDS ratios AND improve ability to access more financing.
For the observant readers you may be wondering, “if the mortgage payment is reduced then I know have to pay my mortgage over 30 years!”. Simple solution to this concern is taking advantage of your lenders prepayment privileges. If your lender allows you to prepay 20% per year then take the $532.26/month mortgage reduction and use it to PREPAY down the loan. Now your ACTUAL amortization is still 20 years but your mortgage payment has been reduced. Win-win solution.
HELOC (home equity line of credit) products are a great way to access funds for investments. One thing many people don’t realize is that even though most line of credits (LOCs) require interest only payments which helps with cash flow, lenders use a different formula to calculate affordability. On LOCs, majority of lenders will take the LOC balance and convert it to some sort of benchmark rate and amortize this over 25 years for mortgage applications. Eg – A $250,000 LOC balance is calculated using a benchmark rate of 5.39% over 25 years which works out to be a monthly payment of $1,510.01. Even though the ACTUAL LOC interest only payment is $770/mth. This creates a much larger monthly expense and in some cases can be an issue when qualifying for lending. An easy solution is asking your lender to CONVERT the actual LOC balance into a mortgage.
Let’s look at an example:
Client currently has a $250,000 LOC balance at a rate of PRIME + 0.50% or 3.70% as of today’s date. On a mortgage application the monthly payment used is $1,510.01. By converting the LOC balance into a mortgage using a rate of 3.39% then the new monthly payment is now $1,104.04 or $405.97 less. This lower payment can put the applicant in a better position when qualifying AND will allow them to save on interest costs. Note that the ACTUAL monthly payment is increased VS the interest only on LOCs but does provide more buffer for future qualifying.
We’ve seen plenty of mortgage changes in the last several years with each change making it slightly more challenging to obtain financing. There will be many individuals who will find themselves in a difficult position when looking to obtain financing but the people who understand how these rules may affect them and are strategic in their ability to adapt will continue to be successful.