Just over a decade ago, it was possible to buy a home in Canada with no down payment — financing 100% of the purchase price — and extending the repayment period for that borrowing over a 40-year period.
A lot has changed since then and one of those changes has been a steady tightening of the rules governing mortgage financing in Canada, especially for mortgages guaranteed by the Canada Mortgage and Housing Corporation (CMHC). The latest such set of changes will take effect on July 1, 2020.
To understand those changes, a bit of background is required. When Canadians buy a home, they must provide a percentage of the purchase price as a down payment. Where the purchase price of the home is $500,000 or less, the minimum down payment is 5%. However, where the down payment made on such a home is less than 20% of the purchase price, there is a requirement to obtain mortgage default insurance. While there are private companies which provide such insurance, in many cases the insurer is CMHC.
Although the borrower/home purchaser pays the premiums on the mortgage default insurance issued by CMHC, it’s actually the lender (usually a bank or other financial institution) who is protected. Essentially, CMHC guarantees that if the homebuyer defaults on his or her mortgage obligations, the Agency will step in to limit any losses incurred by the lender.
Like all insurance providers, CMHC imposes requirements on those who apply for mortgage default insurance and it is those requirements which will change on July 1 (effective for any new applications made on or after that date).
As of July 1, the following new requirements will apply.
New limits on the amount of non-mortgage debt which prospective homeowners can carry
Most Canadians carry debt in some form besides their mortgage debt (car loans, credit cards, lines of credit, etc.), and that non-mortgage debt is factored into the determination of the credit-worthiness of the mortgage insurance applicant. There are two measurements used — Gross Debt Service (GDS) and Total Debt Service (TDS). The first (the GDS) is a measure of housing costs, and includes mortgage payments, property taxes, heating and, where applicable, condominium fees. The second measurement (the TDS) includes housing costs plus all other debt-related payments. In each case, the total amount of debt-servicing obligations is measured as a percentage of gross household income.
The changes which take effect on July 1 will place more stringent limits on the amount of both housing and non-housing debt costs which applicants can have. Prior to July 1, CMHC requirements were that GDS and TDS for an applicant should be no more than 39% and 44% respectively — that is, GDS of no more than 39% of gross household income and TDS of no more than 44% of gross household income. For new applications made after June 30, those numbers will tighten, and applicants will be required to have GDS and TDS ratios of no more than 35% and 42%, respectively. In other words, housing costs which make up the GDS must be no more than 35% of gross household income and total debt servicing obligations which make up the TDS must be no more than 42% of gross household income.
A requirement that at least one of the prospective homeowners have a credit score of at least 680
Most Canadians are familiar with credit scores, which are widely used in assessing the credit-worthiness of an individual. Briefly, a credit score is a measure of both the amount of debt currently held by an individual and the individual’s past history in managing credit. A credit score can range from 300 to 900.
Previously, CMHC had required that applicants for mortgage default insurance have a credit score of at least 600. After June 30, that requirement will increase, as at least one member of the household will need to have a credit score of at least 680 to meet the CMHC’s requirements.
Changes to the rules around borrowing to obtain a down payment
While mortgage insurance applicants have been required to have a down payment of at least 5% (where the purchase price of the home is $500,000 or less) there have, to date, been no restrictions on how that down payment can be obtained. On July 1, for those seeking CMHC mortgage insurance, that will change.
Optimally, a down payment comes from the savings of the prospective home purchasers. However, it is not uncommon for that down payment to be obtained from other sources, including private borrowings (often from parents) or borrowings from other sources like lines of credit or even credit cards. Regardless of the source of the funds, CMHC was prepared to treat the borrowed down payment funds as an asset of the prospective home buyers. However, that policy will change and the new rule will be that where the down payment arises from borrowed funds (whatever their source) CMHC will no longer consider those funds to be an asset of the applicant — or, as set out in the CMHC announcement of the changes “[n]on-traditional sources of down payment that increase indebtedness will no longer be treated as equity for insurance purposes.”
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.
