Why The CMHC Made Drastic Rule Changes For Mortgage Applicants

Last week the CHMC announced that it would be introducing a new set of stringent guidelines for approvals on mortgages starting July 1st.  Since the CMHC insures any mortgage with less than 20% down, this basically means all the banks are forced to use these new guidelines in order to approve new mortgage applicants.  In this article we’ll take a look at the new rules, what they mean for consumers and also speculate on why the CMHC has decided to change the rules.

What Are The Main Rule Changes from CMHC?

The Canadian Mortgage and Housing Corporation outlined the following rule changes coming into effect July 1st, 2020 across Canada:

  • Minimum credit score requirement moves up to 680 from 620
  • Borrowing of down payments will no long be allowed countrywide
  • GDS ratio (gross debt service) must be under 35, previously 39
  • TDS ratio (total debt service) must be 42, previously 44

Minimum Credit Score – this is actually quite a significant change, with the required credit score increasing over 9.6% for all applicants.  This means that people with late payments or any significant defaults in recent history on their credit report will likely be shut out of the mortgage market when the new rules come into effect.  Now more than ever, it’s becoming increasingly important to maintain a pristine credit report and the new CMHC score requirements further underscore the importance of credit worthiness for the banks when making lending decisions.

Borrowing Of Down Payments – this is a less significant change in terms of scope of impact, since most Canadian homebuyers do not borrow their down payment and are able to afford the 5% minimum required for a mortgage.  Overall I think this is a very positive rule change as the ability to borrow down payments surely has resulted in many cases of people buying homes they couldn’t afford to maintain payments on.  Since buying a house is a massive financial commitment, my opinion is that requiring people be able to save a modest 5% down is a good barrier to entry to ensure responsibility on all sides.

Gross Debt Service Ratio – the GDS ratio is used to look at the relationship between taking on the costs of owning a particular property in relation to your income.  It uses all the reasonably expected costs of home ownership added together and divided by your annual income to get a percentage ratio of the GDS to income.  Here is the formula used by CMHC:

  • Mortgage Payments + Property Taxes + Heating Costs + 50% of Condo Fees (where applicable) / Annual Income = GDS Ratio

So for example a $2,000 mortgage payment, $400/month of property tax, $200 heating fee and no condo fees for someone making $100,000 per year would result in a GDS ratio of 31.2%.  With the new rules, the acceptable GDS ratio drops 10.25% which represents another significant change in terms of the amount of debt CMHC is allowing Canadians to take on for a mortgage.

Total Debt Service Ratio – the TDS ratio is used to combined your GDS ratio with everyday living expenses to get an overall picture of your financial health in relation to your income.  The formula used by CMHC is:

  • House Expenses (using GDS criteria) + Credit card interest + Car payments + Loan expenses / Annual Income = TDS Ratio

For example, someone with $30,000 a year in housing expenses, no credit card interested, $6,000 in car payments and $6,000 in loan payments making $100,000 a year would have a TDS ratio of 42%, which is the highest allow under the new rules.  While this was the least significant rule change in terms of percentage drop (only down 4.5%), it will have a big impact on Canadian borrowers who tend to hold significant amounts of debt comparatively on the world stage.

Why Did the CMHC Make These Changes Now

Overall debt has been rising steadily in Canada over the last number of years and with the absolute boom in real estate prices everyone that can has been getting involved in the markets.  Since credit is cheap and availability of debt was widespread, there are many people that overextended themselves into real estate during the good times when Air BnB and flipping could net most a very good profit.

While these new rules won’t do much for current owners, it’s clear that the CMHC and by proxy the banks are going to take a much more conservative approach when it comes to lending money for home purchases.  The underlying fear, is of course that people will be unable to pay the debt on the properties and in some cases would end up defaulting.  Given the massive economic disruption of Covid-19 this is definitely a reasonable fear on behalf of the banks and the CMHC.

By introducing much more stringent guidelines for who can qualify and be insured, CMHC is protecting consumers, the banks and the economy from potential further damage down the road.  It means it’s going to be a lot higher to buy a house in Canada starting July 1st, and only time will tell how it impacts the market in terms of demand and pricing.

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