September 5, 2017

Many Canadian banks use TDS (Total Debt Service) and GDS (Gross Debt Service) Ratios to help them determine how much money you can afford to pay for your mortgage.  The rules and guidelines for getting people into the largest single debt they will ever carry are somewhat fuzzy.

As a first time homebuyer you can still purchase a house with 5% down payment, as long as the mortgage is insured by a third party mortgage insurance company.  But where does the down payment money come from?  Lenders are notorious for “fudging” the numbers – giving the borrower a line of credit or lending extra money in a “cash back” deal to help them qualify for a mortgage.

Realtors also come up with interesting schemes to help people qualify for something that they really can’t afford.  But why would they do that?  It’s all about our global obsession with money and stuff.  The Realtor wants you to purchase the most expensive house you can because their commission is a percentage of the sale price.  Banks too get a percentage of the loan value – and in the end you have to live somewhere and why wouldn’t you want a nicer home?

So what about the 80% rule? You shouldn’t be able to refinance your house for more than 80% of the value through conventional lenders. O.K. so go to unconventional lenders or private lenders – if they are willing to take the risk, at a higher interest rate, you’re in!

One of the biggest and most questionable expenses for home owners is the so called “mortgage insurance” that is usually purchased through CMHC (a crown corporation) – as you’ll learn, even the government is in on the game.  You pay as much as 3.35% of the loan value up front (usually from borrowed funds, borrowed from an RSP, a line of credit or on a mortgage in a cash back arrangement or otherwise) plus 13% of that amount out of your own pocket (not from borrowed funds) as an insurance premium to insure the lender.  That way the lender is guaranteed that if you default on payment and the property gets sold through a power of sale or foreclosure the lender still gets paid from the insurance proceeds.

Well that is where the buck should stop (pardon the pun) but it doesn’t!  Once the lender has been paid out for its deficiency that arose from what may very well have been a questionable lending decision I the first place – the insurer (CMHC) will come after you to pay the shortfall.   So where was the insurance? Fascinating isn’t it?  Imagine if you died and your insurance company paid out your beneficiaries in accordance with the terms of the policy then came after your heirs to repay them?  Ridiculous!

The poor insured – it is the “poor” that need to be insured – frequently have had to borrow the insurance money from the same lender that they acquired the mortgage from.  So any down payment on the house is reduced by the value of the lump sum insurance premium, but is added into the financing and interest is paid on that amount (double jeopardy).

Now in Britain there is talk about capping mortgages to a value that is four times annual salary.  In Canada the mortgage rules have already been set to require that borrowers qualify for a mortgage with interest at a higher rate than the rate at which they are negotiating the mortgage.  So for example the Investors Group was offering a 1.99% mortgage but in order to qualify you may have to qualify as if the rate were 5%.

Alright are you confused?  I certainly am.  If you happen to be self-employed the rules and guidelines get even fuzzier.  It is worth remembering that mortgage brokers represent the lender as well as the borrower and they don’t want to expose the lender to unnecessary risks.  Some mortgage brokers view you as a commission they want to get you into the biggest possible mortgage in order to generate larger earnings.

What is the right formula to qualify for a mortgage?  For that question there is no easy answer you’ll have do the math – the debt isn’t going away for 25 years.  When you add the value of the interest to the purchase price the cost of a property increases very significantly.  And if you are like most Canadians you won’t pay down your mortgage – you will keep adding to it as you get into trouble with your credit cards.