Most people finance the purchase of their homes with a mortgage loan. Historically, financial institutions such as banks or other lenders in relation to giving a mortgage loan required at least 25% of the purchase price of the property as a down payment, there after loaning the remaining 75% in a mortgage. It is also true that generally purchasers of real estate spend a maximum of their Gross Monthly Income (GDI) on the principal, interest and taxes related to the purchase of the property and the mortgage. Lenders such as banks use established formulas in order to calculate the exact amount of a mortgage loan, they think the purchaser of the property can reasonably handle. This is done by factoring in the purchaser’s current debts and several other expenses that may be involved in owning a property.
The Two Formulas generally used are:
1. Gross Debt Service (GDS) ratio: the total monthly housing costs otherwise known by the technical term ‘Gross Debt Service’ (GDS), this is a percentage of gross income (prior to deductions like income tax) needed to pay the costs related with the purchaser’s home. Costs can include mortgage payments, property taxes and utilities; and
2. Total Debt Service (TDS) ratio: With this formula the percentage of gross income (before any deductions like income tax) needed to cover the costs associated with your home, such as mortgage payments, property taxes and utilities, plus any other debts, like credit card payments, or lines of credit and/or car loan payments.
Mortgage Rate Stress Test
The Office of the Superintendent of Financial Institutions (OSFI) of the Government of Canada in the beginning of 2018 (January) made amendments to the mortgage rules of 2016, now requiring Home Purchasers to take what is known as a Mortgage Stress Test in order to qualify for a mortgage loan from a lender. Although this test existed before the amendments, prior to the amendments only those home owners who made a down payment of less than 20% and there fore needed mortgage insurance were required to take the Mortgage Stress Test. With the 2018 amendments purchasers who have made a down payment of more than 20% and do not have or need mortgage insurance are now also required to take a Mortgage Stress Test.
The stress test is conducted at the stage of the mortgage loan insurance application when purchasing a home. The objective of the Mortgage Stress Test is to ensure that the purchaser of a home will financially be able to afford the mortgage and sustain payments if interest rates were to rise.
Following are the requirement for homeowners to pass the Mortgage Stress Test;
Insured Mortgages (those with less than a 20% down payment are required to have mortgage insurance);
- Home owners must qualify for a loan at a negotiated mortgage rate in their mortgage contract as well as the Bank of Canadas fixed 5-year posted rate.
Uninsured Mortgages (those with over a 20% down payment are not required to have mortgage insurance);
- Home owners must qualify for a loan at a negotiated mortgage rate in their mortgage contract as well as the Bank of Canadas fixed 5-year posted rate, or, qualify for an increase in their current mortgage rate by 2% (whichever is greater).
It is also important to note that both insured and uninsured buyers:
- Cannot have a GDS ratio of more than 39%. (CMHC normally restricts the qualifying GDS ratio to 35%, nevertheless, borrowers with reliable and good income and credit are allowed to exceed these guidelines up to the maximum 39%); and
- Cannot have TDS ratio of more than 44%. (CMHC normally restricts its TDS ratio to 42%, nevertheless, borrowers with reliable and good income and credit may be allowed to exceed these guidelines up to the maximum 44%)
The GDS and TDS ratios are used by lenders to calculate the maximum amount they will be able to lend to the home buyer. It is important to note however the Mortgage Stress Test under the new rules is not applicable to ‘Grandfathered loans’ .
The following are referred to as ‘Grandfathered Loans’ ;
- Any loans which were taken before October 17th, 2016, and their renewals,
- Any mortgage loan insurance applications submitted before October 17th, 2016,
- Any legally binding Commitment by the Lender to make the mortgage loan before October 17th, 2016; or
- Any legally binding agreement or contract of purchase and sale entered into by the buyer for which the loan was secured before October 17th, 2016.
Additionally, the Mortgage Stress test is not required for Mortgage renewals, provided however that the renewal is done with the existing lender.
For more information please contact one of our experienced Real Estate Lawyers at MEHDI AU LLP.
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