June 27, 2012 By Madhavi Acharya-Tom Yew
Last week, Finance Minister Jim Flaherty announced new mortgage rules meant to cool off the overheated housing sector and help Canadians tame sky-high household debt levels.
If you’re not sure that you can meet the new mortgage criteria, you have a couple of difficult choices to make.
You can: pay off your debt first, save more for a larger down payment, or lower your budget for your new home.
The government made these following changes, which take effect July 9:
- The new maximum mortgage amortization for a government-insured mortgage will be reduced to 25 years from the current 30 years. That’s for home buyers who have a down payment of less than 20 per cent. Conventional mortgages will still be offered on a 30-year basis.
- The new gross debt service limit is set at 39 per cent from the current 44 per cent. (High-ratio borrowers are already capped at 35 per cent.)
- The maximum amount Canadians can borrow when refinancing a property will be reduced to 80 per cent from 85 per cent of the value of their homes.
- Government-backed mortgage insurance will no longer be available for homes with a purchase price of more than $1 million.
How will the changes affect you? Here are some examples:
For a household of $75,000 annual income with $50,000 down payment and no household debt, with a 30-year amortization on a 3.29 per cent mortgage with a 5-year term, the purchase price would be nearly $414,000.
The monthly mortgage payment would be nearly $1,590.
With all else being equal, with a 25-year amortization, this family would be able to afford a home with a purchase price of nearly $375,000. The monthly payment is unchanged.
“That can be a significant difference in some markets,” said Farhaneh Haque, director of mortgage advice at TD Bank Group.
That means the home you really want may be just out of reach, particularly in a hot market such as Toronto or Vancouver. The flip side is that you will have more equity in your home right away, with a smaller mortgage and less debt.
“Sure you’re buying a house that may be more modest, but it’s more affordable, too. The bigger the house, the more expensive it is to maintain. For a first-time buyer with a modest down payment, it makes sense and helps manage the monthly budget,” Haque said.
Under the new rules, your monthly housing costs shouldn’t be more than 39 per cent of your gross monthly income. Housing costs include your monthly mortgage payments for principal and interest, property taxes and heating expenses. In fact, experts say it should not be more than one-third, or 33 per cent.
To calculate that, add your gross household income from your and your spouse’s salaries, as well as other sources of income and multiply the amount by one-third. Your monthly debt load should be lower than that.
Now take it a step further. Your entire monthly debt load cannot be more than 44 per cent of your gross monthly income. That includes your housing costs plus your other debt payments on car loans, credit cards, or lines of credit payments. Experts say it should not exceed 40 per cent.
If you are close to the cut-off, have a conversation with your financial adviser or mortgage broker.
“Do you really want to be on the edge with your total debt ratios? You want a buffer for a rate increase. If you’re already at 37 per cent in today’s rate environment we can show them what happens if the rate goes up by 1 per cent,” Haque said.
“Regardless of the changes that were announced, you’re always advised to have a bigger down payment because it makes home ownership that much more comfortable for you. If you have other debt, focus on getting a handle on that and paying that debt down before you take on a mortgage because that’s a heavier and longer commitment.”