In an effort to try to curb the growing amount of mortgage debt, the Canadian Government announced additional lending criteria that new borrowers buying after October 17, 2016 will need to meet in order to qualify for a mortgage.
Mortgage lenders are now required to stress test mortgages to see if borrower’s incomes could handle a rise in mortgage rates. Previously, when you applied for a mortgage, it was typically done based on a five year mortgage rate, but the rate was generally discounted. Now, mortgage lenders will be required to qualify high ratio borrowers (those who are putting down less than 20 per cent) at the five year posted mortgage rate. The difference in these rates vary, but the previous discount was sometimes upwards of two per cent. When you put in context that the average selling price in Toronto last month for homes was $755,755, a hike of a couple per cent can be a substantial amount on your mortgage payment.
“Will these changes make it harder to qualify for a mortgage? On the surface yes, but that isn’t necessarily a bad thing. What these changes also accomplish is to help homeowners reduce their vulnerability to financial disaster if rates go up or if the market pulls back even slightly. More debt means more vulnerability, while less debt means more immunity against interest rate changes in your debt load,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.
“Homebuyers in cities where prices are continually rising are taking out more and more debt just to keep up. The problem is that when you are stretched so thin with mortgage debt you literally have no room to move. If you owe more than you own, or if your income can’t handle a higher payment, you may be at risk of losing your house altogether, “says Schwartz.
So, if you are shopping for a home, plan on qualifying through this new mortgage stress test. If you are currently a homeowner, it isn’t a bad plan to give yourself a debt stress test, so that you can anticipate how you might handle any interest rate changes and tweak your budget accordingly.
What is my debt-to-income ratio today?
The point of a debt stress test is not just to determine if you can afford your debts today, but to make sure that you can comfortably afford them tomorrow. Start by looking at your debt-to-income ratio.
It varies from lender to lender, but on average a debt-to-income ratio should be under 40 per cent (closer to 35 per cent), but obviously the lower the better. What would happen to your debt load if your mortgage payment increased by a per cent or two?
Don’t forget that every time your mortgage is up for renewal, you are subject to interest rates at the time, so it may be possible that this is a scenario you will face one day.
High debt ratio? Build some room to move
If your debt ratio is higher than it should be, you can take steps today to reduce your vulnerability. The way to accomplish that is by widening that gap between what you own and what you owe.
You can start by attacking your debt. If you have substantial debt from multiple lenders, you may want to consider a consolidation loan, where you can whittle away at your debts in more substantial chunks, while building up cash flow to help with your savings.
You can also pay down your mortgage more aggressively, taking advantage of lump sum and pre-payment options.
Don’t accumulate more debt
It goes without saying, in the quest to own more than you owe, don’t take out new debt. The less debt you have, the more in control you’ll be if (and when) interest rates do climb.