With the new mortgage rules coming into effect across Canada, many homebuyers are wondering what it means for them, and whether they can still enter the market at all. One of the new rules applies a stress test to borrowers, which means they need to qualify at a higher rate when they have less than 20 percent as a down payment. Before these new rules, mortgage borrowers who took a 5-year fixed-rate mortgage only had to qualify for the mortgage payment based on the interest rate they were getting. For example, if the current 5-year fixed-rate mortgage is at an interest rate of around 2.34 percent, their qualifying payment would be based on that. Now, with the new rules, that same borrower would have to qualify for a rate at the Bank of Canada’s 5-year fixed posted rate, which is currently 4.64 percent.
The new rules aim to make sure that if interest rates ever go up and are much higher than they are today, homeowners will still be able to make their payments. But, the result is also an approximately 20 percent decrease in the amount of mortgage money available to borrowers.
Undoubtedly these changes will impact first-time home buyers, many of them millennials. It could mean they have to scale-down and shift their plans to purchasing a home with a smaller mortgage. The fact is, these rules are here and they will have some effect on the market. It’s largely out of our control. But, there are factors that buyers can focus on that are in their control to maximize their affordability—one being their credit score.
A higher credit score could result in a higher mortgage pre-approval amount.
Why your credit score matters:
Canadian lenders are required to follow specific rules for mortgages that have a down payment that’s less than 20%. These rules are set by qualifying ratios called Gross Debt Service Ratio (GDSR) and Total Debt Servicing Ratio (TDSR).
GDSR is your mortgage payment, heat, taxes, and strata payment applied against your monthly income.
TDSR takes the calculation above and adds other debts like credit card debts, line of credit, etc. and applies that against your monthly income.
The basic outline of these rules offer two levels to qualifying: ratio rules for a credit score under 680 and ratio rules for a credit score over 680. • If your score is under 680 your max GDSR is 35% and your max TDSR is 42% • If your score is over 680 you max GDSR is 39% and your max TDSR is 44% • Higher credit scores get rewarded with an additional 4% GDSR and 2 % TDSR What does that mean?
A low credit score could knock off 4% of qualifying room for a mortgage. Based on the median total income of Canadian families, listed as $79,000 (from Statistics Canada 2014), that could amount to a difference of approximately $27,000 on your mortgage.
For example, someone whose credit score is 650, with a median household income, whose additional debt is $400 a month, will have a GDSR of 35% and a TDSR of 42%. At that calculation they’ll be approved for a mortgage of approximately $378,000 (based on today’s 5 year posted rate and 25 year amortization). Take all of the same factors but when applied to someone with a credit score of 750; their GDSR will be 39%, and TDSR 44%, allowing them a mortgage of approximately $405,000. That’s a significant difference when it comes to buying a home.
Despite its importance, 47% of Canadians don’t know where to check their credit score, and 56% have never checked their score*. Your credit score is basically a financial report card, made up of your credit history. Credit scores range from 300 to 900 and are based on a credit score algorithm. The more positive credit history you have the better, and typically mortgage lenders like to see at least two forms of active credit reporting for at least two years.
The credit score algorithm is dynamic and made up of different aspects of your credit history, including payment history (35%), utilization ratio (30%), length of credit (15%), types of credit (10%), and inquiries (10%).
The two main things that can impact your credit are missing payments and your utilization ratio (how much of your debt you have used).
I recommend the following tips to help people improve their credit scores, starting with checking their score:
The first step to improving your credit score, is knowing your credit score and monitoring it on a regular basis. Every Canadian with a credit history should know their credit score because a bad credit score could cause not only financial limitations, but also affect how quickly they’ll achieve key milestones in their lifetime.
Take care of late or outstanding payments.
Do an inventory and make sure all minimum payments are up to date. Don’t miss any payments, ever. Missing $4 on a payment is the same as missing $400 in the eyes of the credit bureau.
Stay within the limit. Set an imaginary limit of 70 % of your approved limit on your credit cards and lines of credit and do not go over it—even if you pay your balance off every month. Doing this will keep your credit score healthy. If you tend to carry a balance on your credit card, try to keep it under 35 % of your total credit card limit.
If your score is below 680 and you’re hoping to buy a home, you can start taking the necessary steps to improving it. If your score is low strictly because of utilization, it could improve in approximately as little as 30 days if you pay down your balance below 70%. Paying down your debt mid-month instead of waiting until the end of the month will also help improve your score faster. If your score is low because of your payment history, it will gradually improve over about 12-18 months with on-time payments.
The mortgage rule changes are out of your control, but having a strong credit score is. So if you’re planning to own a home, it’s good place to start.
This story was created by Content Works, Postmedia’s commercial content division, on behalf of Mogo.
Chantel Chapman, Special to Financial Post | October 27, 2016 | Last Updated: Nov 2 4:37 PM ET