New Mortgage Rules: Myths and Truths

Over the past two weeks, I’ve been asked countless times – and there’s no hyperbole there, why I haven’t written about the new mortgage rule changes, and how they might affect the market.

Well to be quite honest, I think it’s much ado about nothing, and the “changes” are modest, compared to changes enacted by CMHC in the past, which of course, had no effect.

But I’ve heard so many mistruths about the new mortgage rules, and seen so many incorrect reports in the media, that I figured it’s time to clear the air.

I’ll call in reinforcements from my mortgage broker today so we can set this straight…

mortgage_house

Thanks to Joe Sammut from Mortgage Architects for taking the time to answer my questions on this.

I’ve come up with five areas where I think the misunderstandings are running rampant, and that’s based on both what I’m seeing in the media, and what I’m hearing from my clients.

So I’ve sent those five sections to Joe, and below is a piece he and his team have put together.

Enjoy!

 


 

Don’t have a clue what’s going on with the market changes?

You’re not alone.

The changes that took place on October 17 have undoubtedly raised some questions among the general public. And while the dust settles, banks, mortgage professionals, realtors, and other industry experts will all be figuring out exactly what the day-to-day will look like moving forward.

There’s no definitive forecast of what these changes will bring. But we can certainly dispel some myths in the meantime.

Below are some of the largest myths plaguing the real estate and finance industries today:

1) Low-ratio means uninsured

Typically, when someone buys a home with less than 20% down, they must insure their mortgage through either CMHC, Genworth, or Canada Guaranty. CMHC is the most popular so we often hear people referring to high-ratio mortgage insurance as the colloquial “CMHC” which I’ll use throughout the rest of this article. While these mortgages are insured, it does not mean that other mortgages are not.

There are actually two other ways in which a mortgage could be insured, regardless of the loan-to-value ratio. One way is if the loan is obtained through a “bulk insuring” lender. These lenders are typically the monoline lenders you hear us talking about such as CMLS or Radius Financial.

These lenders will insure their entire book, regardless of loan-to-value because it allows them to offer the security their investors need while staying competitive in the mortgage market.

The second way a low-ratio mortgage could be insured is through a Big-5 bank purchasing insurance on a portion of their book. It’s essentially the same as above except the big banks don’t need to do this to appease investors, but rather to secure their already low-risk loans because it’s so low-cost.

These just go to show you that high-ratio and low-ratio do not necessarily mean insured and uninsured.

The mortgage changes on October 17 specifically refer to insured mortgages but the silver lining is that between now and November 30th (when more mortgage changes will take place) we still have Big-5 banks with the ability to opt out of bulk insuring and thereby sheltering clients from certain changes such as stress testing.

 

2) Every buyer’s affordability just dropped by 24%

While there have been some cases of affordability dropping, it isn’t a constant effect across all borrowers.

The new stress testing rules essentially “pretend” that your mortgage payment is qualified based on a higher rate than you are actually paying to ensure you can afford some volatility in the market. This was already the case on every variable mortgage and fixed mortgages with terms less than 5 years.

If you were pre-approved before for any of these mortgages, your qualification hasn’t changed at all.

Having said that, if you were pre-approved based on a 5 year fixed rate, your qualification will have certainly gone down. Is it always 24%? Not really, that will depend on your situation but it can climb that high for certain buyers.

 

3) Banks and monoline lenders have different rules

Banks and monolines are technically governed by different regulations simply because banks have an actual charter whereas monoline lenders do not. That isn’t to say that they have different rules though.

While each lender may have specific underwriting guidelines such as the territory they will lend in or the types of supporting documents they will accept, for the most part, every bank has to follow the same rules as long as they are playing in the “A” space. Qualification is fairly consistent – if you qualify for a certain mortgage size with one bank, your qualification should be roughly the same at all banks as long as you fit the “A” profile meaning decent enough credit, good income, and the right territory and property type.

 

4) Banks and monoline lenders are completely independent

This isn’t so much a common myth as it is a common misconception from our clientele.

When clients shop the market themselves, they are mostly restricted to the Big-5 as well as some smaller “off-brand” banks such as PC Financial and Tangerine. A broker gives access to many more lenders that don’t have physical branches for a buyer to access.

The impression that many clients have is that each of these banks and lenders is completely independent. The fact is, many of the smaller brand and monoline lenders are funded by the Big-5. This has no impact on a buyer’s options but is still something worth noting.

 

5) Mortgage backed securities are a bad thing

Anyone who’s seen The Big Short or has any bit of understanding surrounding the financial crisis of 2008 knows that mortgage backed securities (MBS) are a scary concept. While they were instrumental in a lot of the market turmoil in 2008/2009, they do not have anywhere near as much of an impact in Canada. A major difference lies in how mortgages are registered and administered in Canada. Mortgages that are obtained in “A” space are almost always credit-worthy, safe loans.

They are oftentimes insured and pose very little risk to the borrower, the lender, the insurer, and the Canadian public. When a Canadian mortgage is transferred from one creditor to another, it is most often done in the form of a refinance – the new creditor offers up the funds to pay out the old creditor and a new mortgage is registered. This allows each creditor to vet the client prior to lending.

By contrast, a lot of mortgages in the US are registered once and then sold multiple times throughout the life of the loan. The risk can be somewhat the same, but each time a loan is sold, it is sold based on the original creditors criteria and is oftentimes grouped into a book of multiple mortgages. This is the basis of mortgage backed securities. When they work, they work well. But when creditor ratings become more and more construed as the loans are sold six, seven, and eight times, it can make the loan(s) riskier.

Luckily, we don’t have a system like this in Canada…yet. With the new mortgage changes, many banks will likely need to find new ways to offset their risk.

Lumping their mortgages together and selling them is a way for them to remove the risk. But again, because of the way mortgages are registered in Canada, these lumped mortgage portfolios will tend to be safer both for the banks and whomever is buying them. There is going to be an interesting market for Canadian mortgages in the near future but will we see anything like the housing crisis in the US because of them? Definitely not.

The 2008 housing collapse was a combination of risky lending practices, over-leveraging, and overbuilding. It was a deadly combination which we have yet to experience in Canada nor have we even allowed those conditions to exist. If MBS end up becoming a norm up here, we will most likely see a very different type of security; one that is safer, more regulated, and better managed.

Joe Sammut
Mortgage Architects
1-888-575-4403 x21
joesammut@mortgagegate.ca

7 Comments

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  1. Dave Woodman says:

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  2. daniel says:

    So now all mortgages over a million, regardless of LTV, are not eligible for CMHC insurance in the bond market. I’m curious to see how much (if any) this adds to the mortgage rate on these homes (i.e. almost everything in Toronto). I think we need a bay street financier more than a mortgage broker for the answer on this one.

    1. Joel says:

      Right now most lenders are going to be about the same or 0.10% higher on their rates. We may see all rates creep up a bit in the near future to cover off the difference.

      1. Daniel says:

        well that’s a reassuringly small spread.

        So will the banks now securitize the mortgages without insurance? Is the 10 bps just the spread in rates between securitized and non-securitized? Or is it 3rd party private mortgage insurance or some other kind of CDS?

  3. Long Time Realtor says:

    I’ve been around long enough to remember when EVERYONE had to qualify at the posted rate and (gasp!), you had to have 25% down to go conventional. Everything old is new again?

    1. Condodweller says:

      I remember as well. What I don’t know is if there was such an animal as unconventional mortgage back then; and if anyone paid less than the posted rates.

  4. Kramer says:

    I especially like the point on already having to qualify for higher rates on other mortgage terms, most notably variable term mortgages of certain lengths. I found myself in this position last year and it did not impact me because I wasn’t stretching to begin with.

    It seems like this change to higher qualifying standard for 5-year fixed would be directly tied to the fact that 5-year fixed are almost as low as the variable rate… the spread is not as big as it was 6-months ago. Wow though, locking in at 5-years 2.39%… so hot.

    Seems responsible to me, and demand is still voracious… this will only lead to buyers stretching themselves less… which is a good thing given where we are in the cycle. Take on less mortgage, and pay it down faster, or find a bigger downpayment.

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