Dropping Mortgage Rates - Great For Buyers, But Sellers Beware
We are currently seeing historically low interest rates on mortgages. This is a fantastic benefit for buyers, making their mortgage payments lower and home ownership more affordable. But when rates drop quickly it can mean significant penalties to break a fixed rate mortgage. This can have a big impact on anyone breaking their mortgage before their term ends. And while porting to a new property can allow you to get credited back for the penalty, sellers do not always have that option or they can actually save more breaking the current mortgage for a new, lower rate.
If you are selling and not buying again, refinancing, choosing not to port, or you cant meet your lenders porting requirements, the penalty will be your cost to bear. Ill explain why penalties are higher when rates drop and why a seller may need to call their lender more than once to confirm their penalty.
Dropping Rates = Higher Fixed Mortgage Penalty Calculations
When a borrower breaks a fixed rate mortgage before their term is complete, they will pay a penalty. That penalty is generally the greater of a 3-months interest charge, or an Interest Rate Differential charge (IRD). The concept behind an IRD is to charge the borrower for what the lender loses in letting them out of the mortgage early. When rates drop significantly over a short period of time, the lender loses more by letting a borrower out of their mortgage because they will fetch lower returns when they re-lend out that money again.
Example: $350,000 mortgage with a 5-year fixed term at 3.5% breaking it after 2 years
The lender looks at the rate they are charging for a 3-year fixed mortgage (because that is how much time is left in the borrowers term). Lets say their current 3-year fixed is 2.2%. The interest rate differential is 1.3% (3.5% -2.2%).
IRD penalty = $350,000 current mortgage x 1.3% x 3 years = $13,650
3 months interest = $3,063
Penalty to break this mortgage is $13,650.
This is a simplified example and lenders do vary on how they do this calculation. Some lenders go even further and calculate in the discountoff their posted rate you initially received, making penalties even higher.
Variable rate mortgages have a different penalty calculation. The standard penalty charged is 3 months interest, making them far less expensive to break early.
Selling? Check Your Mortgage Penalty Again
The penalty on your mortgage is always moving around based on what rates are doing and when in your term you are breaking it. So, if you called in the spring to find out what your penalty to break your mortgage would be, that penalty could be much lower now if that lenders shorter-term rates have dropped. If you are considering a sale or refinance be sure to confirm your mortgage penalty first.
Align Sale To Your Renewal Date
If you do have a high penalty charge and have an upcoming renewal, you can save thousands by selling with a possession date that falls on or after your mortgage maturity date.
If you are looking at selling, make sure you understand your options. Contact me to calculate what youll come away with on a sale and to understand the mortgage considerations.
CMHC's Big Announcement - And Why It Has Little Impact
On June 3rd, Canada Mortgage and Housing Corporation (CMHC) took the mortgage industry by surprise when they announced significant changes to their underwriting guidelines, effective July 1st. These will impact buyers with less than 20% down. The following week the other two mortgage default insurers in Canada, Genworth and Canada Guaranty, announced they would not be following the same tightening measures. This has taken most of the impact out of CMHCs changes, as lenders will just send files that do not fit CMHCs tighter measures to the two insurers that allow them. That said, it is still important to understand what they are and how they may impact some home buyers.
CMHC Changes To Underwriting
Starting July 1st, CMHC will implement the following changes:
Maximum affordability ratios dropped - Maximum TDS (Total Debt Service - the share of income that goes toward paying all housing costs, including mortgage, taxes, condo fee and heat) will be dropped from 39% to 35%. The maximum GDS (Gross Debt Services - the share of income that goes towards paying all housing costs as well as any other debt commitments) will be dropped from 44% to 42%. For a strong credit buyer without debts it will drop your purchasing power by approximately 10%.
Tougher credit qualification - at least one borrower must have a beacon score above 680 (currently 600).
No borrowed down payments - (ex.unsecured line of credit)
You can check out their media release here:
Who Will Be Impacted?
Now that the other two insurers are not tightening rules, most borrowers will not be impacted. But there are those that do not have the option of using Canada Guaranty or Genworth that will have to meet tighter requirements. Here are some examples:
Mobile Home Purchases - CMHC is the only insurer who offers default insurance on mobile home purchases on rented or leased land, so those buyers will need to meet the tougher requirements.
Porting CMHC Insurance - Buyers are able to port their default insurance policies in a purchase, which is particularly beneficial if you are selling and buying after only a year or two in a property. If your first property purchase was default insured with CMHC, then in order to port it you would need to qualify for the new purchase under the tougher requirements.
One Less Option - There are many situations where one insurer is not willing to proceed, where another will. They can decline because of a feature of the property, location of a property, condo document concerns, or something they deem risky about the buyer. In these situations, if a buyer is purchasing beyond CMHCs new affordability maximums, or their credit score does not meet the new requirements, CMHC will not be an option. For these buyers, instead of three chances for an approval, there are now two.
Cautious Lending Market
While it was a win for consumers to have Canada Guaranty and Genworth stay the course instead of following CMHCs tougher guidelines, there is still an overall shift in the lending environment. It is simply more cautious. Lenders and default insurers are making less exceptions and choosing not to approve borderline files (ex. weak credit, recent income drops, etc.). So even if you do not have to meet CMHCs new requirements, improving your credit, paying down debt, and ensuring you have a thorough pre-approval done before you go out purchasing will all help you be successful when you purchase.
Contact me if you have any questions about your mortgage and how they are impacted by these changes.
CMHC Tightens Up Borrower Requirements
CMHC (Canada Mortgage and Housing Corporation) has just announced changes to their underwriting, effective July 1. They are one of three default mortgage insurance providers in Canada. Every mortgage that has less than 20% down payment needs to be default insured. We are still waiting to see if the other two insurers, Genworth and Canada Guaranty, follow along with these changes. If so, it will make borrowing for those with less than 20% down more difficult. CMHC announced the following changes:
Maximum affordability ratios dropped - Maximum TDS (Total Debt Service - the share of income that goes toward paying all housing costs, including mortgage, taxes, condo fee and heat) will be dropped from 39% to 35%. The maximum GDS (Gross Debt Services the share of income that goes towards paying all housing costs as well as any other debt commitments) will be dropped from 44% to 42%.
Tougher credit qualification at least one borrower must have a beacon score above 680 (currently 600).
No borrowed down payments (ex.unsecured line of credit)
You can check out their media release here:
How Could This Impact You?
If all the insurers move ahead with this, here is how it will impact you:
Decreases your buying power - for a strong credit buyer without debts it will drop your purchasing power by approximately 10%.
Must have strong credit to purchase
Revisit your pre-approval once these rules come into effect your maximum mortgage may change
Why Is CMHC Doing This?
CMHC has recently stated they are concerned about house values dropping and how that would impact new home buyers. They are concerned they could become underwater, or owe more on their mortgage than their home is worth. To counteract that they are reducing the size of mortgage new buyers can take on and lending only to borrowers who are stronger from a credit perspective.
To track any updates related to this, please connect with me on my Facebook page. I will post what the other insurers choose to do in response to this announcement: