Deciphering the New Canadian Mortgage Financing Rules for Investors

Deciphering the New Canadian Financing Rules for Investors

Rules around mortgage financing and bank lending guidelines in Canada have changed significantly. With tighter regulations and a shift in how applications are reviewed, these changes continue to impact investors and the industry alike.

In June, the Finance Minister Jim Flaherty announced another round of changes to financing rules in an attempt to slow down Canadian household debt. Similarly, the federal regulator for banks and insurance companies, OFSI (The Office of the Superintendent of Financial Institutions Canada) have also made changes to federal guidelines – creating a substantial impact on who receives funding and how much money is being lent.

The Bank of Canada is concerned that some investors could face financial difficulties if and when the interest rate changes. Recent statistics from Stats Canada indicate that Canadian household debt-to-income ratio reached a new high of 152% in the first quarter of 2012, up 2% from last year.

For more information and to better understand the impact of the changes, you can review information presented by:

The Impact of Changes

As the new rules come into effect, the consequence for real estate investors and the housing market is substantial. Latest research indicates there is already a decline in real estate in some parts of the country, in terms of both sales price and volume. The end result of these tighter regulations mean that there are fewer approvals, reducing demand and as a result, softer real estate markets.

Even with the Federal changes, some lenders are taking it even further. Here are some of the new changes that have recently been put in effect:

  • HELOC’s (Home Equity Line of Credits) were dropped from 80% to a maximum of 65% LTV (loan to value. As per the OSFI regulations, some lenders will still allow for a re-advance able product up to 80% financing, but only 65% of the product is re-advanceable.

For example, your investment is worth $100,000. $15,000 mortgage, $80,000 total facility and $65,000 max re-advance able (Line of Credit) –making principal payments on the mortgage will not increase the LOC portion. Not all lenders have changed, but many have.

If you currently have a HELOC, you don’t have to worry – these changes don’t apply to you. Only provincially regulated financial institutions are affected. That means that credit unions don’t fall under the new rules.

  • Stated income (when you can’t prove income) programs were reduced to a maximum of 65% LTV
  • Renewal on variable rates – means you need to re-qualify at 5% (not the original discounted rate)
  • Net worth lending (equity lending based on the property and not the applicant) programs were lowered to a maximum of 65% LTV
  • Free Down Payment programs are eliminated (except for credit unions)
  • New to Canada program (for new immigrants) were lowered to a maximum of 65% LTV
  • Net Worth program reduced from 75% to 65% with one lender.

Shorter amortization periods, lower refinancing limits and tougher rules on ratios for calculating debt allowances – it all adds up to additional paperwork to prove income for both the self-employed and salaried employees.

According to Kyle Green from Mortgage Alliance, “rental investors who rely on rental income to qualify for mortgages, the new rules make it much more difficult to qualify.” To side step these challenges, he suggests considering Credit Unions. Regulated at a provincial level, they do not need to follow the federal dictates.

PREPARING YOUR FINANCIALS FOR SUBMISSION

Here are some tips to prepare for your next real estate investment purchase…

Salaried Employees

As an employee, banks look favourably on the stability of income that employment provides. You will need to show the following items:

  • Letter from your employer – indicating your annual salary and cheque stub
  • Three months of banks statements
  • Notice of Assessment from the Canadian Revenue Agency
  • Your T4 statement from your taxes
  • Liquid assets – RRSPs, stocks or mutual funds

The banks are looking for proof of income and that you have the right debt coverage ratio. They will review your debt ratio to decide whether your investment will generate enough cash to cover the mortgage commitment.

Each lender has different requirements, but in most cases, they use rental offset for qualifying purposes. In most cases set the maximum gross debt service ratio at 39% and have reduced the total debt service ratio to 44%.

The financial institutions use 50% of the rental income and set it against the principal, interest and tax. Under these new rules, many investors are not able to qualify for investment properties.

Review the following links to access more information regarding the qualification process:

Self Employed Investors

For self-employed investors, banks are looking to confirm all sources of income – both professional and rental. They will also want to confirm and verify that funding for the down payment and that it has been present and available for the last 90 days. They will request the following items:

  • Three months of banks statements
  • Notice of Assessment from the Canadian Revenue Agency
  • Your T4 statement from your taxes
  • Leases of existing properties
  • Verification of property ownership

If you own a corporation, you will also need to provide:

  • Corporation bank statements
  • Profit and loss statements and possibly full sets of financial statements for at least 2 most recent years
  • Registration of the corporation

All financial institutions are looking to determine if you have the income to support the investment. By looking at your T4 Statement; they also review the amount of tax you have paid over the last two years in order to qualify your investment financing. Ensuring that all income sources are tracked and accounted for is an important part of this qualification process.

Credit Bureau Check

Once a year, you are entitled to pull a free credit bureau to check your rating. Equifax and Transunion both offer reports to check your credit file. I recommend that you review your credit bureau regularly, as this will help you know what shows up before you invest. It will help you assess areas for improvements (like regular on time payments) to help diminish any risks that you may have.

Review Your Financials

With banks reviewing all of your financial activities, I recommend that you take the time to check the status of all financial accounts. To keep on top of things, I also suggest that you put a binder together for your current real estate investments. Keep track of property reports and lease agreements. Have everything ready, but only provide them if they are requested.

Here’s a checklist for you to review:

Investor mortgage financing checklistIn the end, getting financing has become more involved. The banks have been put on notice by the Minister of Finance and OFSI and real estate investors are finding that they are paying the price of these new rules.

The new financing rules may make the purchase of your next investment more difficult. With the help of a qualified and credible broker and by having your financial affairs in order, these difficulties can be minimized.

By Andrew Schulhof
31 Oct 2012