Are you currently scouring the lending market for a mortgage? If so, you might be aware of the rules and regulations surrounding the mortgage approval process, which can be confusing and fraught with challenges.
Your financial standing directly impacts the type of mortgage you qualify for.
Lenders will scrutinize your income, credit score, debt obligations and other financial details to determine your eligibility before making a decision on your application.
For this reason, familiarizing yourself with the various mortgage rules in Canada is a wise course of action before entering the market for a mortgage.
Down Payment of 20% or Higher
Let’s assume you’ve collected enough money to contribute a down payment of 20% for your home purchase.
In this case, the type of mortgage you’d qualify for is called a conventional mortgage.
One of the benefits of a conventional mortgage is that you’re exempt from purchasing mortgage insurance.
However, there are still other criteria your lender will consider before decisioning your application.
These include the stress test, your credit score, and debt service ratios.
The stress test evaluates if you’re capable of servicing your mortgage payments at a rate higher than the one stated in your mortgage contract.
Your lender will determine if you’re eligible for a mortgage based on one of two rates (whichever is higher):
- The minimum qualifying rate (MQR) of 5.25%
- Your assigned interest rate plus 2%
Here’s an example of how the stress test works in practice:
Suppose you live in Ontario and apply for a 5-year fixed-rate mortgage on a home with a sales price of $450,000.
You decide to put down a 20% down payment, and your lender, the Bank of Montreal (BMO), assigns you a 5% interest rate.
You earn an annual income of $130,000 and estimate your monthly heating costs and property taxes to be $280 and $325, respectively.
Currently, you have no other debt obligations.
Would you be able to qualify for this mortgage?
In this case, BMO will use a 7% rate (assigned rate of 5% + 2%) when assessing your ability to handle the mortgage payments, as it’s the higher of the two rates prescribed in the stress test.
By entering the above data into BMO’s mortgage affordability calculator, we discover that the maximum mortgage amount you would qualify for is $516,836.
With a $90,000 down payment ($450,000 x 20%) your financing requirement is $360,000.
As a result, you would easily pass the stress test when it comes to this mortgage.
The maximum you could pay for a home and still qualify for a mortgage would be $606,836.
For a conventional mortgage, lenders prefer to extend mortgage financing to borrowers with a credit score of at least 650.
Requirements vary, however, with some lenders willing to extend credit to homebuyers with lower scores and some imposing higher thresholds.
To be safe, you should aim for a credit score of at least 700.
Debt Service Ratios
In general, A lenders like to see GDS under 32% and TDS under 40%.
RBC for example provides guidance of 30 to 32% for GDS and 37 to 40% for TDS.
Debt service ratio requirements vary from lender to lender, with some having more flexibility than others.
According to the first Residential Mortgage Industry Report released by the Canada Mortgage and Housing Corporation (CMHC) on July 16, 2019, more than two-thirds of mortgages issued in Canada in 2018 were conventional mortgages.
Down Payment Lower than 20%
Suppose you’re planning on contributing a down payment of less than 20% on your home purchase.
In that case, you’ll have to apply for a non-conventional mortgage.
The rules that govern these types of mortgages differ slightly from those of their conventional counterparts.
The primary difference between a conventional mortgage and a non-conventional mortgage is that the latter requires mortgage insurance and therefore has an insurance premium payment that’s required.
This insurance is added to a mortgage to protect the lender should you default on your loan.
The Canada Mortgage Housing Corporation (CMHC), Sagen (formerly Genworth), and Canada Guaranty are the institutions that offer mortgage insurance.
Your lender determines your premium using a sliding scale based on your required financing relative to your home’s appraised value.
You can expect to pay between 0.60% and 4% of your mortgage amount should you purchase from the CMHC, the most common issuer of this insurance product.
Non-conventional mortgages are subject to the same stress test requirement imposed on conventional mortgages.
Your lender will assess your capacity to manage your mortgage at the MQR of 5.25% or your contracted rate + 2%, whichever is higher.
Credit score requirements for non-conventional mortgages are more stringent than they are for conventional mortgages.
On July 1, 2020, the CMHC increased the minimum credit score needed for insured mortgages from 600 to 680.
Others have been known to still take credit scores of 600.
Regardless, it’s advisable to aim for a credit score at or above 700 to receive the most competitive mortgage rates and terms.
Debt Service Ratios
The Canada Mortgage and Housing Corporation (CMHC) won’t insure mortgages where the borrowers’ gross debt service ratio (GDS) and total debt service ratio (TDS) exceed 39% and 44%.
As a result, you should strive to keep your ratios below these ceilings.
New Mortgage vs Mortgage Renewal
When your mortgage term ends, you’ll have one of two options:
- Renew your mortgage for another term with your current lender
- Transfer your mortgage to a new lender and enter into a new contract
Should you opt to renew with your current lender, you’ll have the opportunity to lock in a new rate and renegotiate your contract terms and conditions.
There are no additional criteria to satisfy when renewing your contract – you do not need to go through the full approval process again.
Conversely, should you choose to switch lenders, you’ll have to requalify for your mortgage and go through the full approval process again, including the stress test.
Suppose you decide to break your mortgage contract early to take advantage of a refinancing opportunity.
In this scenario, you’ll still need to pass the stress test before your lender issues you a new mortgage.
This prerequisite applies whether you’re seeking to refinance with your current lender or an alternative lender.
More likely than not, you’ll also have to pay a financial penalty for ending your mortgage contract before it matures.
If you’re planning to tap into your home equity by taking out a line of credit on your home, you’ll be subject to the mortgage stress test.
Frequently Asked Questions
- Do you have to put 20% down on a second mortgage?
It depends. If you intend to use your second property as a personal residence, lenders may issue you a mortgage with even a 5% down payment. Still, you’ll likely face hurdles getting approved for one since your debt service ratios will be substantially higher due to your current mortgage obligation.
If you’re purchasing a second property for investment purposes, most lenders will demand a down payment of 20% due to the riskiness of the endeavour.
- Can I get a mortgage 5 times my salary?
While this used to be an informal benchmark in the past, once you take into account the mortgage stress test and expenses such as property tax and heating, a more realistic amount is 3.5 to 4 times your salary.
Alternative or B lenders may still approve a mortgage that’s equal to five times your salary.