The CMHC strikes again: six new debt service guidelines that could affect you

As last year’s tighter mortgage rules continue to be felt in the Canadian housing market, the CMHC issued new guidelines recently that will make mortgage lending in Canada even more rigorous.

The guidelines seek to clarify the key inputs of the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios used by lenders to assess mortgage eligibility. These ratios are important because they largely determine what each borrower can afford and whether or not they qualify for a mortgage.

In the past, lenders could take liberties with how inputs like income and debts were determined. Not anymore: the CHMC’s new guidelines leave very little wiggle room in this regard, which will inevitably lead to some mortgage applications being turned down, but should also make for more prudent lending.

Check out the new input guidelines below to see if your mortgage application could be affected:

Input #1: Regular Income

When it comes to qualifying for a mortgage, regular household income is the most important input and probably the most often fudged too. 

The new CMHC guidelines now explicitly require that lenders receive supporting documentation on income, employment status and sustainability of employment. 

Input #2: Variable Income

Variable income will now be subject to much stricter scrutiny. Income from variable sources such as bonuses, tips, and investments must be earned for at least two consecutive years to be included in the debt service calculations, and lenders cannot use an amount that exceeds the average income of those years. 

The CMHC does make an exception if variable income has been rising for at least four years: in this case, mortgage professionals can use the most recent (and highest) income figure.

If an applicant’s variable income has fallen from one year to the next, lenders are instructed to apply “due diligence” to factor in the downward trend.

Input #3: Self-Employed Income

Self-employed Canadians have always had a harder time getting a mortgage, and the new CMHC guidelines won’t make it any easier. The good news is that they won’t make it dramatically harder either!

Lenders are instructed to take “reasonable steps” to obtain supporting income documentation from self-employed borrowers. The new guidelines state that a “reasonable effort must be made to assess the plausibility of the income” and continue with the warning that “relying solely on borrower disclosure is not acceptable.”

Input #4: Rental Income

Assessing income from rental properties can be a nebulous undertaking. The CMHC knows this and the new guidelines treat rental income very conservatively. 

Gross rental income is now subject to a host of deductions under the guidelines: mortgage interest, property taxes, and heating expenses must be subtracted from all rental income before it is included in the debt service calculation.

Alternatively, the rental unit’s mortgage principal, interest, property taxes and heating expenses must be included in a borrower’s “other debt obligations” when calculating the Total Debt Service ratio.

Either method has the net effect of decreasing the power of rental revenues to boost a borrower’s total income.

Input #5: Unsecured Lines of Credit and Credit Cards

Debts are also given stricter scrutiny. The new guideline for revolving credit is simple but airtight: “no less than 3% of the outstanding balance” must be included in the monthly debt payment calculation.

Some lenders had previously used interest-only payments in their calculations to help borrowers qualify. The CMHC guideline effectively shuts this practice down.

Input #6: Secured Lines of Credit

In the new guidelines, secured credit must now be assessed as if it is the equivalent of a loan amortized over 25 years, with an interest rate of no less than the current 5-year Benchmark rate set by the Bank of Canada. The resulting monthly payment from such a loan will be the figure used in the TDS calculation.

Here again, the practice of using interest-only payments will no longer be allowed, potentially leading to some mortgage applications being denied.

Clarity Is a Good Thing

These new guidelines really do bring an additional measure of clarity to the mortgage application process. Standardizing the inputs that banks rely on to make mortgage decisions should reduce the phenomenon of borrowers ‘shopping around’ for the least rigorous lender.

Better news still is that most banks have already been using these guidelines for some time, so the impact on the housing market should be minimal. And for borrowers who are stretching to get a mortgage, at least now they will have a clear understanding of what lenders require.