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Experts advise people with a high ratio of debt to income to never make changes that could require them to be requalified before the mortgage closes, such as increasing debt load, changing the mortgage term, etc.John Bazemore/The Associated Press

Some mortgage applicants with high debt loads got an unpleasant surprise last week.

They submitted their applications for variable-rate mortgages, were told they qualify, and then the Bank of Canada hiked rates, by a startling one percentage point.

Lenders quickly increased their prime rates by the same amount.

Mortgage default insurers saw this, and decided that new borrowers should prove they could afford a much higher “stress test” rate, even if rates were lower at the time they applied.

That led to some lender approvals being overturned, triggering outrage from affected homebuyers and mortgage professionals.

On Tuesday, this country’s three default insurers – Canada Mortgage and Housing Corp., Sagen MI Canada Inc. and Canada Guaranty Mortgage Insurance Co. – issued guidance on the matter. If you’re buying a home with less than 20 per cent down, here’s what you need to know.

First off, in a case where you apply for a mortgage, an insurer approves you and then rates go up – you don’t need to worry about any of this.

The problem occurs when you apply and rates go up while you’re waiting for the insurer to underwrite your application. In that case, the insurer will use the new higher stress test rate.

Now, most insured mortgages are instantly approved so there’s no time for rates to go up in the process. But, for more complex files, approvals can sometimes take more than a day.

While infrequent, delays might happen where an insurer asks for a co-signor, for example. During that time, if the Bank of Canada happens to hike rates and your lender’s prime rate goes up, it could be a problem.

“This is another example of why it is important for homebuyers to make sure that their mortgage application has been approved before waiving the financing condition in their purchase and sale agreement,” said Susan Carter, a spokesperson at Sagen.

What to remember

As noted, this only affects people with a high ratio of debt to income. We’re talking borderline borrowers here. Albeit there’s a lot more of them than there used to be.

If you’re one of these borderline insured borrowers with high debt ratios, here are four tips:

  • Apply at least a week before any expected Bank of Canada rate hikes;
  • never make changes that could require you to be requalified before your mortgage closes, such as increasing your debt load, changing the mortgage term, etc.;
  • never lift financing conditions until you get an official approval from both the lender and insurer;
  • preapprovals are typically qualified using the stress test rate at the time you request a full approval. Keep in mind that rates can go up a lot between when you’re preapproved and officially approved.

Appraisal games

In some Canadian markets, home prices have fallen more than 10 per cent in less than 60 days. As a result, appraisers are using “time adjustments” whereby they discount comparable properties that sold a month ago by multiple percentage points in larger markets, says Leigh Walker, president of Lawrenson Walker Real Estate Appraisers Ltd.

Underappraisals are increasingly emboldening mortgage originators and homeowners to pressure appraisers into finding other comparables – to boost their lower appraisal value. But most of the time that doesn’t work. “Appraisers have no choice but to use the most recent comps,” says Chris Bisson, chief executive of Value Connect.

“Although it happens, in 20 years I can count on my hands how many times we’ve missed a comparable,” Mr. Walker adds. “But, we’re human, so if we’ve missed something we’re always happy to include it.”

Will the Feds allow longer amortizations?

“We’re going to need maybe more financial innovation in order to help people deal with [affordability],” former Bank of Canada governor Stephen Poloz said in a recent Veritas Investment Research presentation. “Maybe we’ll look at longer-range mortgages ... as a solution.”

In the U.K. for example, amortizations go up to 40 years. Here, such long-term amortization are limited to non-prime mortgages, with mainstream banks still limited to 25 years (insured) and 30 years (uninsured).

Mr. Poloz may be on to something. Canada too should have 40-year mortgages, if for no other reason than borrower flexibility. Paying a mortgage quicker isn’t the smartest use of cash for everyone.

Problem is, when you allow people to borrow longer, they qualify for bigger mortgages, and hence they pay more. That inflates home prices, exactly what we don’t need this year (but may need if prices keep plummeting).

If the feds want to give people flexibility with zero home price impact, there’s a simple solution. Allow 40-year amortizations but make people qualify on a 30-year amortization, which means they can’t get approved for a bigger mortgage and thus pressure home prices.

Variable rates break through 4 per cent

After the Bank of Canada’s 100-basis-point wake-up call last week, the lowest nationally available uninsured variable rate is north of 4 per cent for the first time since 2008. To qualify at most lenders, you have to prove you can afford a rate of more than 6 per cent.

That’s still easier to do than qualifying for a five-year fixed at more than 7 per cent, however. And it’s exactly why countless indebted borrowers will continue choosing variable rates over fixed rates.

By the way, Allison Van Rooijen, vice-president of consumer credit at Meridian Credit Union, said demand has surged for mortgages qualified at the contract rate instead of the federal stress test rate.

“The secret is starting to get out,” she says, adding that such borrowers have minuscule default rates, comparable to borrowers stress tested at much higher rates. “We’re lending to people not to houses. When underwriting, we try to see what [banks] miss.”

In other mortgage news, the best insured five-year fixed rates are now a whopping 55 bps below comparable uninsured rates. (There are 100 basis points, or bps, in a percentage point.) That gap is more than double its 10-year average.

Why? There’s a view that mortgages are riskier with home prices recently decreasing, according to Blake Dumelie, vice-president of capital markets at Nesto. That makes government-backed default-insured mortgages relatively more attractive to lenders.

On top of that, uninsured mortgage funding (debt issuances, covered bonds, etc.) is increasingly more expensive compared with insured mortgage funding, such as government-guaranteed mortgage-backed securities and Canada Mortgage Bonds.

Lowest nationally available mortgage rates

TERMUNINSUREDPROVIDERINSUREDPROVIDER
1-year fixed4.59%Manulife4.09%Radius Financial
2-year fixed4.74%Simplii4.49%Radius Financial
3-year fixed5.04%Simplii4.54%Marathon
4-year fixed5.09%Simplii4.69%Radius Financial
5-year fixed5.09%HSBC4.54%True North
10-year fixed5.84%HSBC5.84%HSBC
Variable4.09%HSBC3.69%HSBC
5-year hybrid4.59%HSBC4.74%Scotia eHOME
HELOC4.55%HSBCN/AN/A

As of July 20

Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.