On Thursday, June 4 2020, Canada Mortgage and Housing Corporation (CMHC) announced new, tighter mortgage borrowing criteria that will apply to all insurance applications beginning July 1, 2020. CMHC is Canada’s largest mortgage insurer and offers mortgage default insurance to property buyers to ensure lenders are protected in the event that borrowers fail to pay their mortgages. Mortgage default insurance is mandatory for high ratio mortgages, which are mortgages where the down payment is between 5% and 19.99%.
CMHC cited the impact of COVID on several sectors of the economy and its recent 12 month forecast on home price declines as the key factors in its decision to change its underwriting criteria. According to CMHC President and CEO, Evan Siddall, these changes 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.”
New Criteria Include Higher Credit Scores, Lower Debt Service Ratios, and Limit Down Payments from Non-Traditional Sources
Specifically, CMHC announced three updates to its criteria for new insurance applications, beginning July 1:
1. Gross Debt Service (GDS) ratio tightened to 35 and Total Debt Service (TDS) ratio updated to 42
GDS and TDS ratios are used to calculate a homebuyer’s credit eligibility by comparing annual income to debts and ongoing housing costs.
A borrower’s GDS ratio is a calculation of housing expenses including mortgage payments, property taxes, utility costs and condo fees (if applicable) as a percentage of annual income. The TDS ratio is a calculation of all GDS ratio expenses plus other debts including car payments, credit card expenses, or loan expenses, as a percentage of annual income.
Previously, the CMHC maximum GDS ratio was 39 and maximum TDS ratio was 44.
According to James Laird, president of mortgage brokerage CanWise, a buyer with an annual income of $100,000 and a 10% down payment would previously have qualified to buy a home valued at up to $524,980. Under the new rules, the same buyer would only be approved to buy a home worth $462,860 — a reduction of 12 per cent. Therefore, buyers impacted by the stricter debt service ratio criteria need to save longer for a down payment for the same home.
2. At least one borrower must have a minimum credit score of 680
A borrower’s credit score is a measure of credit-worthiness based on factors including past payment history, the dollar value of debt owed, length of credit history and more. A higher score indicates stronger credit-worthiness.
Under the new criteria, at least one borrower on the insurance application must have a minimum credit score of 680, up from the current minimum of 600. According to the CMHC, 5.9% of CMHC-insured mortgages in the first quarter of 2020 fell under the 680 score.
3. Non-traditional sources of down payment will no longer be treated as equity for insurance purposes
Borrowers can no longer use credit cards, unsecured personal loans or lines of credit to fund a down payment. All borrowers will be required to source down payments from their own funds when the new criteria comes into effect on July 1. The CMHC notes that eligible sources of funds include “savings, the sale of a property, non-repayable financial gift from a relative, funds borrowed against their liquid financial assets, funds borrowed against their real property, or a government grant.”
Private Insurers Weigh In on Changes to Determine Full Impact on First-Time Buyers
Of the changes announced, limitations on maximum debt-service ratios are likely to have the greatest impact on prospective first-time home buyers – particularly those in Canada’s largest cities where property prices are typically higher. These buyers may see their purchasing power reduced if the updated criteria is adopted industry-wide.
Specifically, the impact on high-ratio borrowers will be most profound if both of Canada’s private default insurers Genworth MI Canada and Canada Guaranty choose to follow CMHC’s lead and adjust their debt service ratio limits. On June 8, Genworth announced that they do not plan to change their underwriting criteria. As such, high-ratio first-time home buyers with eligible credit scores who have saved at least the minimum 5% down payment from traditional sources will still have default insurance options and may not see their purchasing power affected.
Mortgage default insurance is not mandatory for low-ratio borrowers – those with a down payment of at least 20% of the purchase price of a home. As such, the new CMHC criteria do not directly impact this group of home buyers. Low-ratio borrowers that choose to purchase mortgage default insurance can review their options with private insurers if they do not fulfill the revised criteria from CMHC.