February 17, 2010

Wake up and smell the coffee

Yesterday Finance Minister Jim Flaherty announced some minor changes to the mortgage lending rules.

These changes which take effect on April 19th 2010 are designed to save the general home buying public from themselves. For the last year I have been talking, writing and sometimes even scolding my clients who were trying to buy a home that they can’t afford. The erroneous mind set was that the bank had told them that according to their salary and today’s interest rates they could afford a certain size mortgage. The key words are today’s interest rates. The buyers were taking this figure as gospel, putting a minimum 5% down payment and amortizing their mortgage to the maximum 35 years. Today’s interest rates are rather low and so the buyer truly believes that he can afford the payments. The truth is that today he might be able to barely make the payments, but what will happen a few years down the road when the mortgage is up for renewal, the interest rates have risen about 2.5 -3% (which is not unheard of) and your salary has remained more or less stagnant. A standard mortgage of $200,000.00 today based on a five year rate of  3.79 % amortized for 35 years will cost you $857.00 monthly. This sounds great but in five years time if interest rates have gone up to 6.25 your monthly payments will have ballooned to $1128.00 per month costing you an additional $3256.00 after tax dollars per year. Can you as a buyer truly afford that?

The following are 3 changes the Finance Minister has introduced to the mortgage lending rules.

1)      Those proposing a down payment of less than 20% must qualify their salary against a 5 year fixed interest rather than trying to fit their income to match a lower 3 year fixed rate.

This is I believe a weak attempt to protect the buyer from himself. Firstly the 5 year rate does not represent the 2.5 – 3% rate that interest rates could jump. Even if you take today’s 2% 5 year variable rate that most banks are offering, it falls short of even a 2% increase when compared to the 3.79%      5 year fixed rate offered today. I believe that the buyer should also be qualified against a shorter amortization period as well.

2)      Those who are looking to refinance their homes cannot do so to a value above 90% of the value of their home This was changed from a refinancing loan of up to 95% of the value of their home.

Refinancing to even 90% of the value of your property usually indicates that you are in dire financial straits and would be well advised to sell your home rather than incur greater financial debt.

3)      The 3rd change to the mortgage lending rules requires a 20% down payment on a 1-4 unit property in which the buyer will not be a resident.

Many buyers have been looking to revenue properties as an investment and given the potential rental revenue they figure that their mortgage payments will be covered. They close their eyes to the fact that these rental units could end up vacant for months at a time. The Minister by raising the down payment required is trying to make sure that the investor has to ability to weather any storm such as prolonged vacancies. I am just wondering if he went far enough by not imposing stricter qualification rules.

In any case I hope that these amendments if nothing else will make all buyers wake up and smell the coffee. Do not over extend yourselves by borrowing to the max and find yourselves a good mortgage broker who will be straight with you and warn you of all the pitfalls.

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