Over the course of the last five years, we have witnessed some pretty significant changes to the way that banks and lenders qualify borrowers applying for mortgages; most of these changes have been implemented to make it harder for borrowers to qualify. Gone are the days of $0 down payments, 40-year amortizations and overall lax underwriting practices. Each change that has been made since 2008 has progressively made the process of qualifying for a mortgage that much more difficult.
Further changes were quietly announced last week, by a few lenders, forecasting a strong likelihood many are adopting further conservative lending policies in the near future. Existing unsecured debt payments will be calculated using 3 per cent repayment on the balance, regardless of the contractual amount. Those debts and their corresponding 3 per cent payments ultimately decide how much of a mortgage you qualify for. Obviously, the more debts you have outstanding, the less of a mortgage you qualify for.
Traditionally, banks and lenders have accepted the contractual payments for unsecured debt despite it being lower than 3 per cent of a balance. Over the last 5 years, banks and financial institutions were seemingly handing out unsecured credit at an alarming rate – in many cases, offering more attractive low repayment terms than in years past. Today, it is common practice for your bank to give an unsecured line of credit or credit card and have your minimum payments be set at interest only. To quantify, let’s say that you take a $25,000 line of credit that you have used. At an interest rate of 6 per cent, the bank would only make you pay a minimum monthly payment of just the interest at approx. $125. Lenders and banks previously qualified your mortgage based on the low minimum payments issued by the creditor. New mortgage rules, however, dictate more conservative use of 3 per cent of the balance rather than interest-only when qualifying you for a mortgage. The mortgage company’s underwriting practices now stipulate that they have to use a payment of $750/month (3 per cent of the $25,000 debt you have). That has a serious impact on your qualifying ratios.
Let’s take for example someone that makes $65,000 a year and wants to buy a place. And let’s say that the person only has one debt. That debt is a $25,000 line of credit that they used to help get themselves through school and the payment on that line of credit is just $125/month (only the interest). Prior to the lenders changing their policy, the client would qualify for a mortgage of approximately $325,000. Now, if we insert the new policy of using 3 per cent of the balance on the line of credit and add the payment of $750/month into your liabilities, that means that you would go from qualifying for a mortgage of approx. $325,000 to $200,000. That is a difference of over $125,000 in a mortgage. You can see the potential impact on this could be substantial. Think of someone that is a few years out of university and owing $50,000 on a student line of credit. Even if they are only paying the interest, the bank would use a $1,500/month loan payment which would pretty much mean that they would have a hard time qualifying for any mortgage that they apply for.
The other change was with respect to secured lines of credit and their impact on the qualifying of a mortgage. I often have clients setup lines of credit behind their mortgage, in case of an emergency, just so that they have a safety net should something ever happen – and I feel it makes prudent financial sense to do so. The new policy change that has been adopted by a few lenders now penalizes borrowers for having secured lines of credit against their house. If someone has a $300,000 secured line of credit with no balance on it and they are applying for another mortgage and keeping that property, the financial institutions are now using a monthly payment on that entire $300,000 limit when factoring in how much someone would qualify for. You would be surprised how many people have large secured lines of credit on their homes that they have not used for years and what that could mean should they ever buy another home or investment property, or help a family member qualify for a home. For example, one lender’s calculation for factoring a payment out of the limit is using the limit amount x 4.6 per cent / 12 to determine the monthly payment. If we use a $300,000 limit, it would work out to be a payment of $1,150/month used in their qualifying ratios. I have worked with several younger purchasers who have used their parents as co-signers to help buy a place. You can see if a parent helping their child buy a home would be impacted in a large way just for having available credit with nothing outstanding on it.
This continued tightening of mortgage policies has noticeably put a dent on the plans of several buyers. From first-time to move-up buyers, and everyone in between, it continues to become harder to buy a home. I do think that using the higher payments to qualify borrowers based on their outstanding debts is a more prudent way to look at the affordability and feasibility of owning a place. We must keep in mind that we are also are at 50-year lows on mortgage rates and these lower rates mean you qualify for a higher mortgage than when interest rates move up. Most of these changes will have a positive effect on ensuring people are not biting off more than they can chew, but using a payment on the limit of an unused line of credit is an unnecessary and penalizes the wrong borrowers.
If you would like to contact me, please feel free to call me at 647-352-5825 or email me at [email protected].