Last week, CMHC (Canada Mortgage and Housing Corporation) announced that effective July 1, 2020 it will be tightening the rules for high ratio mortgage qualification. Specifically, the following 3 changes will come into effect:
- The maximum allowed Gross Debt Servicing (GDS) and Total Debt Servicing (TDS) ratios will be reduced to 35% (from 39%) and 42% (from 44%), respectively.
- At least one borrower on the application will have to have a credit score of 680 or higher (increased from 620).
- Non-traditional funds used towards the down payment will no longer be considered by CMHC as equity. This primarily affects buyers who borrow from a personal loan or Line of Credit to raise some of the down payment required to purchase a house.
High ratio mortgage insurance is required for any home purchase where the buyer’s down payment is less than 20% of the purchase price, so these changes will predominantly affect first time buyers trying to get onto the property ladder and young families needing to move up the ladder to a larger home.
The first item is the most significant for our area, because it will affect a large number of people trying to buy a house later this year. Reducing the maximum allowed debt servicing ratios directly reduces the maximum house purchase price that buyers can qualify for when using a mortgage as part of their purchase financing. And in our area, where we already have relatively high property prices compared to average household incomes, this change will effectively put house purchase dreams out of reach for many first time home buyers and young families.
For example, under the current CMHC rules, a young couple with a combined household income of $80,000, no other debt, and savings of $20,000 can qualify for a maximum purchase price of about $385,000 (restricted by the 39% GDS rule). In our area, that’s just enough to get into a half duplex or townhouse starter home. When the GDS is restricted to 35%, those same clients will only be able qualify for a purchase up to $345,000. That’s a $40,000 drop in purchasing power as a result of the 4% reduction in the allowed GDS ratio.
The second point, increasing the credit score requirement, will mean that people with any recent missed payments or high rolling credit card balances (balance more than 50% of the limit) will have a more difficult time qualifying for a mortgage and will likely instead need to wait 3-6 months for their credit scores to heal from minor blemishes. People with good credit are usually in the low to mid 700s, but a missed payment combined with a couple credit inquiries and a few months of high credit card limits can easily drop a credit score by 50-100 points.
The change to non-traditional sources of down payment (item 3) will mostly impact young professional buyers, who graduate from university and enter high paying jobs but have little or no savings. Under current CMHC rules, purchasers must have a down payment of at least 5% (of the purchase price), but those funds can be from any combination of personal savings, gifted funds from a direct family member, or borrowed money from a personal loan or Line of Credit. The borrowers funds are classified as ‘non-traditional’, but they are allowed as long as the applicants have high enough income that they can afford the monthly payments on the borrowed funds on top of the mortgage payments, property taxes and all other debt payments – in other words, as long as that the debt servicing ratios (GDS/TDS) are under the allowed limits. Under the new rules, non-traditional sources of down payment money will not be considered as equity by CMHC, which means applicants will need to come up with the minimum 5% required from either personal savings or a gift from family.
At this time, there are 3 providers of high ratio mortgage insurance in Canada – CMHC, Genworth and Canada Guaranty – with CMHC being the most popular because it is ultimately backed by the Federal Government. For the most part all 3 insurance providers have similar products and qualification criteria, and all 3 charge the same fees for the insurance provided. However, Genworth and Canada Guaranty have announced that they do not currently plan to implement any changes to their underwriting criteria, which will mean for the first time in decades (possibly ever), borrowers will be able to qualify for substantially higher mortgages using Genworth and Canada Guaranty mortgage insurance compared to CMHC.
Because CMHC is a government-backed company, the risk it takes on by providing mortgage insurance is ultimately born by all Canadian taxpayers and for several years now, government critics have decried this increasing risk exposure and point out that by making it easier for buyers to purchase houses with less down payment, the government was fueling higher housing prices, meaning buyers struggled even more to come up with significant down payment funds and therefore had to rely even more on mortgage insurance, and thus causing a continual upward spiral of prices and risk.
If Genworth and Canada Guaranty continue providing mortgage insurance at the current criteria while CMHC tightens it’s own, this will likely lead to a substantial increase in Genworth and Canada Guaranty insured mortgages in the coming years and allow CMHC to reduce it’s own risk exposure (as a percentage of the overall national housing market).