How new CMHC mortgage stress test rules impact first-time home buyers

Planning to buy your first home? Along with becoming a homebuyer, chances are you’ll also be a first-time mortgage applicant. If so, keep in mind that on July 1, 2020, application requirements for an insured mortgage, including a new update to the calculation of the mortgage stress test - will change.

If your down payment is less than 20% of the total purchase price,  you’ll need an insured mortgage. Although you’ll still work with your  lender directly, they’ll connect with one of Canada’s three insured mortgage providers to provide your mortgage.

When borrowers contribute less than 20% for a down payment, the lender and mortgage insurance provider wants added assurance the borrower will make their mortgage payments as agreed. And that’s where the mortgage stress test comes into play.

First introduced in Canada in 2018, the mortgage stress test for insured mortgages requires lenders to check that mortgage applicants could still make payments based on the higher of the Bank of Canada’s qualifying rate. To complete a stress test, mortgage lenders calculate the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios to determine if applicants have an income high enough and debt low enough to make mortgage payments based on the higher of should rates increase.

Learn about these new mortgage rules, how they might affect your home purchasing decisions as a first-time homebuyer, and what to do to make your home ownership dreams a reality.

On June 4, Canadian Mortgage and Housing Corporation (CMHC), one of Canada’s three insured mortgage providers, announced several changes to its underwriting criteria for new insured mortgage applications. Among them were three changes first-time homebuyers should know about.

CMHC announced it will begin limiting the GDS ratio to 35%, and the TDS ratio to 42% for new insured mortgage applicants. This impacts the mortgage stress test.

The GDS ratio represents the relationship between the applicants’ gross income and the total mortgage payment (principal and interest), property taxes, and, if applicable, condo fees. In other words, no more than 35% of your pre-tax income can go towards these costs.

The TDS ratio combines the GDS plus any other outstanding debt payments, such as car loans/leases, student loans, or credit card/credit line balances. The total of these plus the housing costs of the GDS can’t exceed 42 percent of the applicants’ income.

For example, if your household income is $100,000, your GDS (home expenses) can’t exceed $35,000 per year. And your TDS can’t exceed $42,000.

The second change to impact a home buyer applying for an insured mortgage is the introduction of a rule requiring a minimum credit score of 680 for at least one borrower on the mortgage.

Thirdly, CMHC announced that as of July 1, 2020, “non-traditional sources of down payments that increase indebtedness will no longer be treated as equity for insurance purposes.” In effect, this means that your down payment can’t come from borrowed funds that you’re expected to pay back.

According to the CMHC press release, they changed the mortgage stress test in anticipation of the economic impact of COVID-19 on Canada’s housing market. “These actions will protect home buyers, reduce government and taxpayer risk and support the stability of housing markets while curtailing excessive demand and unsustainable house price growth,” said Evan Siddall, CMHC’s President and CEO.

In other words, CMHC wants to make it less likely that homebuyers with insured mortgages will struggle to make mortgage payments in a tougher economy.

It’s important to understand that these new mortgage rules only apply to CMHC insured mortgages. Neither Sagen or Canada Guaranty, Canada’s two other insured mortgage providers, have announced underwriting changes.

These mortgage changes do not apply to uninsured mortgages, typically mortgages where the borrower has a down payment of at least 20% of the purchase price.

These changes will only impact you if:

• You apply for an insured mortgage through CMHC
• Your down payment is less than 20%
• Your GDS and TDS ratios are higher than 35% and 42%, respectively
• Your down payment is from borrowed funds
• You and your co-applicant both have credit scores below 680

So, while the changes may seem significant, the new mortgage rules should only impact a small group of homebuyers.

If these changes do apply to you, here are 4 ways to adjust your homebuying plans:

1. Increase your down payment to more than 20%. This could mean saving for longer or taking on a part-time job or side hustle, or looking at lower-priced homes (Note: CMHC forecasts a 9% to 18% decline in house prices over the next twelve months.)
2. Talk to your financial institution about lowering your monthly debt payments through debt consolidation to improve your TDS ratio. Consider applying for a smaller mortgage to reduce your GDS ratio.
3. In addition to your regular savings, explore other CMHC acceptable down payment options such as non-repayable financial gifts, funds borrowed against other financial assets, or a government grant.
4. Work on improving your credit score. Order your credit report to confirm the information lenders see is correct. Make all of your payments on time and in full and take care to avoid credit card or credit line balances over your account borrowing limits.
5. Check to see if your bank or lender work with Sagen or Canada Guaranty - the other two mortgage loan insurance providers in Canada. They have slightly different qualification requirements and didn't make the same changes as CMHC did with these updates.

Don’t let the impending changes give you stress over your mortgage. Yes, some insured mortgage lending standards are tightening. By taking steps now to strengthen your mortgage application, you’ll not only improve your chances of getting a mortgage approval, but you’ll also improve your overall financial health.