Call it the gap between what you have to pay and what you can afford to pay \u2014 it\u2019s going to be considerable when you qualify for your next mortgage. Now the question is what should you do with that money?<\/p>\n
Ottawa tightened mortgage rules in October and the one requirement that has disrupted the lending world is the stipulation that consumers qualify based on the Bank of Canada posted rate for a five-year fixed-rate mortgage.<\/p>\n
That rate \u2014 it\u2019s based on the most common posted rate of the big six banks for a five-year fixed rate mortgage \u2014 has been stuck at 4.64% since the government announced the new measures in October 2016. Qualifying with that rate is a heavy burden and creating a huge gap when it comes time to deciding how much you will actually pay, considering consumers can lock in a rate for as low as 2.28% for five years, according to ratespy.com.<\/p>\n
\u201cIt is affecting a lot of people here,\u201d said Geoff Willis, managing broker with Vancouver-based Origin Mortgages. \u201cA lot of people look at the interest rate online and think that\u2019s what they\u2019ll qualify on. They go out and buy a new home, they have seven days to firm up a deal, and then they go their bank and find they can\u2019t get financing.\u201d That can mean potentially watching your deal fall apart.<\/p>\n
Here\u2019s the math on how on you will have to qualify in today\u2019s market. Considering the Canadian Real Estate Association said the average home in the country sold for $551,400 in February, that means to qualify for a federally backed loan you\u2019ll need to come up with at least $30,140 to get a loan for $521,260. (Government regulations stipulate that you must have five per cent down on the first $500,000 of a home and 10 per cent on any portion above $500,000 up to $1 million.)<\/p>\n
The rub on the mortgage qualification is that at 4.64%, that $521,260, based on a 25-year amortization, would mean a monthly payment of $2,925.74 but at 2.28% that monthly payment goes down to $2,278.35. The first figure is the one you must qualify for based on a set ratio for how much of your monthly income can go towards debt and housing costs. The second number is what you actually end up paying \u2014 creating a gap and a decision on what to do with that difference.<\/p>\n
Janet Boyle, vice-president of real estate secured lending at Scotiabank, doesn\u2019t see a change in that 4.64% rate any time soon. \u201cI think what you might see is some people wait a little longer and try to grow their down payment so they don\u2019t require (mortgage) default insurance,\u201d she says.<\/p>\n
Under federal rules anybody with less than a 20% down payment must get mortgage default insurance, the premiums payable by the consumer. Loans with more than 20% but backed by the government and securitized, often called bulk insurance and used by smaller lenders who pay the premiums instead of consumers, must also meet the new guidelines.<\/p>\n
The monthly payment becomes key when calculating what is called the gross debt service ratio which mandates that no more than 39% of your average gross monthly income go towards housing costs and that includes mortgage payment, principal and interest, property taxes, heating costs and 50% of condo fees. The total debt service ratio must be under 44%, calculated by taking your monthly gross income and adding car loans or leases, credit card and lines of credit payments and other loans to housing costs.<\/p>\n
\u201cIt\u2019s a little too early to tell the impact, we\u2019ve had less than a quarter to see it,\u201d said Boyle, about what consumers who do qualify at the higher rate will do with their leftover money once their real rate is considered.<\/p>\n
Interestingly enough, Canada Mortgage and Housing Corp. just published a how-to guide book for buying a house with a message that says maybe you shouldn\u2019t borrow as much as your financial institution will allow. CMHC says those ratios should be at most 32% and 39% respectively under its recommended affordability rules.<\/p>\n
So what do to with that extra money? One option is to leave the door open for prepayments.<\/p>\n
\u201cI wouldn\u2019t say people are keeping their payment at that higher level but what I would say is it does drive a selection of a mortgage package which offers a prepayment opportunity,\u201d says Boyle.<\/p>\n
It\u2019s a little too early to tell the impact, we\u2019ve had less than a quarter to see it
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\nMost mortgages in Canada have prepayment terms, some that will let you pay a lump sum of up to 20 per cent of your mortgage off annually. Others will let you increase monthly payments \u2014 both resulting in your principal being paid off faster with less interest being paid over life of the loan.<\/p>\n
\u201cPeople see that payment cushion but they also see the opportunity to pay off a lump sum,\u201d says Boyle.<\/p>\n
Calum Ross, a wealth advisor and author of The Real Estate Retirement Plan: An Investment and Lifestyle Solution for Canadians, says the question of whether you should be using any of that gap money to pay down your mortgage or invest comes down to the age-old question: What is your rate of return?<\/p>\n
\u201cIf most of those people in a higher tax bracket understood the true opportunity cost of paying their mortgage more quickly they would never do it,\u201d said Ross. \u201cI understand the need to lower your debt and get the stress off your brain. But the fact of the matter is if you\u2019ve got more than enough investment to pay off your debt, you\u2019re not stressed about the mortgage.\u201d<\/p>\n
Economist Will Dunning said it\u2019s really only a small minority of Canadians who go for the maximum they qualify for anyway. \u201cMost people won\u2019t be affected by the stress test,\u201d he says, adding his studies have found people start making extra pre-payments as soon as they get a mortgage.<\/p>\n
Paul Taylor, chief executive of Mortgage Professionals Canada which represents 11,500 members, believes the 4.64 percentage is really too high to begin with and doesn\u2019t promote a healthy mortgage market.<\/p>\n
\u201cIt\u2019s to their credit that government has provided us with opportunities to express our concerns to them,\u201d says Taylor, abut recent hearings on mortgage rules. \u201cBut we are five to six months into this and we are seeing cracks in local economies (because people can\u2019t buy homes).\u201d<\/p>\n
Taylor says the whole point of the higher rate was to create a cushion for Canadians in a rising rate environment \u2014 something that hasn\u2019t materialized.<\/p>\n
\u201cThe aim of the stress test is so consumers have excess funds and can purchase consumables like a new fridge and car and help the economy,\u201d said Taylor, referring to statements from government officials. \u201cWe all acknowledge Canadians are very good at paying their debt. Our arrears rates are great. There is less concern about default and more concern about people not having any money to spend anywhere else and that could create a consumer recession.\u201d<\/p>\n