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10 Reasons Why You May Not Qualify for the Best Rates

General Tim Hill, MBA 6 Apr

As mortgage brokers, we know that homebuyers often enter the mortgage process with confident expectations surrounding the rate they expect to receive, only to be disappointed when they can’t qualify for the best rates.

They inevitably always come back with one burning question: why? Why do homebuyers not qualify for the mortgage rate they thought they would?

This is a great and important question, but it can also be a hard one to answer, since there are so many factors in their application that can impact their qualification. Many homebuyers often get caught up in the process and forget about one or two details that the lender will take into account. As brokers, we can help answer that big “why” question by going through the key points lenders look at.

Here are some of the more common reasons why homebuyers who expect to qualify are later refused, or aren’t able to secure the best market rates.

Consumer debt
This is one of the biggest reasons homebuyers are not approved for the best mortgage rates. Having high debt payments, such as auto or credit card payments, can seriously hinder one’s borrowing power.

For example, a $400 car payment and just $10,000 of debt on a credit card can lower one’s borrowing power substantially, depending on their income and how it impacts their debt-to-income ratios, including the Gross Debt Service Ratio (GDSR) or Total Debt Service Ratio (TDSR). These ratios provide the lender with an idea of how the borrower is balancing their debts and income. The maximum GDS ratio must be under 32-39%, while the TDS ratio must be under 40-44%, depending on the lender.

Price increases
Homebuyers often frame their expectations based on the people they know who have recently bought homes, especially those with a similar profile. However, this doesn’t always create an accurate expectation of the market, especially in an environment like today where home prices have been rising rapidly.

For example, if your friend purchased a year ago, the cost of that home could already be up to 30% higher. As a result, your chances of being approved will be less than theirs, even if you have the same income and debt levels. The same applies to rates. What you qualified for last year may be different moving forward as rates continue to rise.

Irregular hours/inconsistent income
Lenders are more likely to use your income if you have guaranteed work hours. Even if you regularly work full-time hours, unless those hours are guaranteed, the lender may not be able to include your full income. The same applies to those who receive bonuses or commissions that supplement their income. The lender will most often use your two-year income average, or your most recent income year on your application.

Self-employment
Those who are self-employed generally have a higher gross income compared to their declared net income due to write-offs and how their taxes are filed. While write-offs may be desirable as a way to reduce income and associated taxes, they also reduce the amount of income that can be used on your mortgage application. This means you may not qualify for as much as you expected based on your gross income level.

Divorce and borrowing power
If you are divorced, your borrowing power can decrease based on alimony or child support payments. If you are making the payments, your debt-to-income ratio will increase, reducing your borrowing capacity. If you are receiving child support or alimony, lenders will want to ensure you are receiving that income consistently in order to include it as part of your income. If it is not being received consistently, there is a chance the lender will avoid using this income source.

Government income inconsistencies
Suppose your file is too heavily reliant on government-subsidized income sources, like a child tax benefit. In that case, your borrowing power will go down, as lenders won’t want the child tax benefit to represent too much of your income. Another way government-related income can be inconsistent for a lender is if they are looking at your prior years of income to determine your future loan repayment abilities. One example would be if you have Canadian Emergency Response Benefit (CERB) payments included as part of your income. Your lender will not likely use CERB income for qualification purposes, and will instead assess your income level as whatever it was less the CERB money. To best prepare for this scenario, ensure that your income is consistent and based entirely on your earnings rather than government subsidies.

No active credit
If you’ve had a previous consumer proposal or bankruptcy, you need to re-establish your credit profile before applying for a mortgage. It’s not just about the amount of time that has passed between declaring bankruptcy and applying for a mortgage. The most important objective should be rebuilding your creditworthiness, proving that you can be trusted with loan repayment.

Over-utilization of credit
You might think that you are well-prepared to apply for a mortgage because you’ve never missed a payment on your credit card. But, before doing so, you need to ensure that your cards are not maxed out. It might surprise you, but consistently maxing out your credit or building up large balances across multiple cards can drop your credit score even if you pay them off in time. Having a lower credit score typically means you won’t qualify for the best-available mortgage rates.

Active collections
If you have any active collections (debts owed on your cell phone or internet bills, for example), they need to be paid off before applying for a mortgage. If you pay them off in time, your credit should not be affected. But keep this in mind, as some people have active collections without even realizing it.

Credit profile issues
Lenders pore over credit profiles very carefully. If there are any inconsistencies, you will not be able to qualify for the mortgage rate you expected. Something else to watch out for is identity fraud. Regularly check your credit report for unfamiliar new accounts. If a fraudster opens a new account using your information, you may not be notified about it until you check your credit report.

When scanning your credit report, be on the lookout for any inconsistencies in personal information, such as the wrong birth date. If you notice any issues, you can file a dispute with the credit bureau. Make sure you check your credit report before any lenders do to ensure everything is up to date and accurate.

How brokers can help
Hopefully this list helps to answer the big “why” question borrowers ask when they can’t qualify for the best rates, and may change their outcome for the next time they apply.

Another thing to keep in mind is that, as brokers, we often have the tools and expertise at our disposal to assist borrowers with more complicated files. If the borrower can’t be qualified by the best-rate lender, competitive alternative lenders can sometimes also get the application done, particularly for borrowers with at least a 20% down payment.

No matter your situation, being over-prepared and knowing exactly how a lender will be scrutinizing your application will help greatly with the overall process and improve your odds of getting a better rate.

https://www.canadianmortgagetrends.com/2022/04/10-reasons-why-homebuyers-may-not-qualify-for-the-best-rates/

Taking a mortgage? Avoid linking it to the big banks’ posted rate

General Tim Hill, MBA 4 Sep

My wife and I recently considered selling a small condo that we purchased in Montreal some eight years ago. The four-year fixed mortgage we have on the asset is of about $200,000, with an annual interest rate of 3.24 per cent.

In retrospect, going with a variable rate would have been a much better choice, but back then, securing a 3.24 per cent rate seemed attractive enough.

We knew that paying off the mortgage in full — a year and a half before it is up for renewal — would trigger some penalties, but when I inquired with Bank of Montreal what would be the exact amount, I was stunned to learn that the penalties would amount to $6,717.

You read it right, a penalty of almost $7,000 for breaking a small mortgage of $200,000 only 21 months before maturity.

How could that be? I asked. What I had in mind is a general rule of thumb that the penalty for breaking a mortgage early equals three months of interest. In our case, this would have cost us about $1,700 in fees. But $7,000?

I looked at my mortgage statement more carefully and realized that I was caught off guard when I renewed it a couple of years ago.

Our rate was indeed locked for four years at 3.24 per cent, but it was defined as BMO’s “posted rate” at the time we took the mortgage – 4.89 per cent – minus a “rate discount” of 1.65 per cent.

In a case like ours, as long as the mortgage matures according to plan, no special penalties will kick in. But if paid early, that “discount” that we received off the posted rate could actually turn out to be quite expensive.

By applying the “Interest Rate Differential” (IRD) — a somewhat complicated calculation that few borrowers fully understand — big banks charge massive penalties that could reach as much as five per cent of the loan (or principal) value.

To be fair, banks should receive some compensation when a client pays a mortgage in full before maturity. When a bank is initiating a mortgage, for example, providing a five-year fixed-rate loan, it’ll typically hedge (eliminate) its interest rate risk by getting into an opposite position to the one it provided to the customer.

If the mortgage is paid in full prematurely, say after three years, the bank will have to cover its hedged position it held against the mortgage. If interest rates change, this could expose the bank to a loss, and the penalties compensate the bank for that loss.

But the way in which Canadian banks are calculating these penalties results in excessive and unfair fees.

In Canada, the Big Six banks have multiple menus of mortgage rates. First, there are the so-called “posted rates.” These rates are typically inflated and should be considered as a sticker price for a new vehicle — a rate that no one should ever pay.

Currently, the Big Six banks’ posted rate for a five-year fixed mortgage is 4.79 per cent. The rate is significantly higher than the Government of Canada five-year bond yield which stands at 0.87 per cent — a good proxy for how much it costs the bank to finance the mortgages they provide.

Then, there are the big banks’ “special rates” or “best available rates” which are the competitive rates that you should aim to lock-in. The five-year fixed special rate at the Big Six is about 2.44 per cent now. This means that banks are willing to initiate five-year fixed mortgages at 235 basis points below their posted rates, which makes you wonder, why are posted rates so high?

If you do your research and negotiate, the big banks will offer you a competitive rate, far below their posted rate. But almost always, they will still link your discounted rate to the posted rate in a way that will trigger higher fees in case you break the mortgage early.

Robert McLister is a mortgage expert and editor at RATESDOTCA. He has been studying the Canadian mortgage market for years. “If you’re asking me, can you get a five-year fixed mortgage from a major bank without any chance of paying high penalties, the answer is definitely no,” he tells me in a phone interview.

There is a good reason why the five-year fixed rate — by far the most popular among Canadians — is so overblown. The IRD, the formula that generates high penalties for the banks, is larger, the higher the difference between the posted rate at the time a mortgage was initiated and the bank’s posted rate with remaining term (for example, two years fixed) when the mortgage is prepaid.

Since the majority of mortgages in Canada start off as five-year fixed, it’s beneficial for the banks to keep the five-year posted rate artificially high.

Mortgage Professionals Canada, the country’s mortgage industry association representing more than 13,000 individuals and more than 1,000 companies, confirms this observation.

In its recent publication, Annual State of the Residential Housing Market in Canada 2020, the association highlights the huge gap between the average posted five-year mortgage rate (4.95 per cent) and the average mortgage interest rate (2.25 per cent), and concludes: “It confirms that, increasingly, the banks’ posted rates are not being set in reference to the actual marketplace.”

Hence, according to Canada’s mortgage professionals, the big banks’ posted rate is basically a scheme.

Lack of competition is one of the reasons why this is possible, according to McLister. “In Canada, we have six big banks that control, directly or indirectly, over four out of five mortgage dollars through funding and direct origination. Most countries don’t have that level of concentration of the banking system,” he explains.

So what should you do the next time you need a mortgage?

The best way to avoid paying high prepayment penalties is to choose a variable-rate mortgage. Then, in most cases, banks would charge you just three months of interest for breaking a mortgage early, which is fair.

But in the current low interest rate environment many are rightfully tempted to lock in a five-year fixed rate. In that case, choose a lender that has just one set of discount rates. Tangerine (owned by Scotia) is one good example. That way, even if you break your mortgage early, penalties are going to be much more reasonable.

Amir Barnea
https://www.stcatharinesstandard.ca/ts/business/opinion/2021/09/04/taking-a-mortgage-avoid-linking-it-to-the-big-banks-posted-rate.html

 

When it comes to mortgage break penalties, big banks are often the worst

General Tim Hill, MBA 15 Nov

Committing to a mortgage for five long years exposes people to the most insidious aspect of residential financing: prepayment charges.

And when it comes to such charges – the penalties you pay come when you back out of your mortgage early – some lenders take a greater toll on your bank balance than others.

Big banks are usually the worst. Mortgage finance companies are often the best.

And these bank competitors want you to know it. More and more, smaller lenders are using their preferential penalty calculations as a selling point, as well they should.

This year I’ve seen lenders such as Equitable Bank, Manulife Bank of Canada, XMC Mortgage Corp., Merix Financial, CMLS Financial Ltd., RFA Mortgage Corp., First National Financial LP, and MCAP all go out of their way to step up marketing and educate consumers on how bad penalties from major banks can be. (Mind you, a few of these lenders also have “no-frills” mortgages with high penalties – for example, 3 per cent of principal. So watch out for those.)

WHAT IS A ‘FAIR-PENALTY LENDER?’

A fair-penalty lender calculates its standard prepayment charges, for lack of a better word, “fairly.”

It does so by comparing your actual mortgage rate to a rate equal to (or close to) what it charges new customers for a time frame similar to your remaining term.

Unlike Big Six banks, fair-penalty lenders don’t use arbitrarily inflated rates (“posted rates”) in their calculations. That only serves to drive up penalties.

So why doesn’t everyone get a mortgage with a fair penalty lender?

Well, because most people are conditioned to pay more for big bank financing. Among other things, they trust the brand, like the convenience or like knowing they can walk into a branch to talk to someone if there’s ever a problem (although, for most people, mortgage problems after closing aren’t too common). And the cost of that convenience is steep.

A SIMPLE EXAMPLE

Suppose you’re a major bank customer with a regular 3.19 per cent $300,000 five-year fixed mortgage that you got one year ago.

Now imagine you:

  • Need to consolidate debt into your mortgage;
  • Just found a new job in a different city and must sell and rent;
  • Want to break and renegotiate to a lower rate;
  • Have to break the loan early for some other reason – maybe because of a loss of income, divorce, inability to get a fair rate from your bank on a “port and increase” (that’s where you move your mortgage to a new property and increase the loan size), or inability to qualify for a port.

In these scenarios, one popular bank would charge you an interest rate differential (IRD) penalty of roughly $16,800 to exit your existing mortgage.

Compare that with just three months’ interest (about $2,400) at a “fair penalty lender.”

To put that another way, the extra $14,400 you’d fork over to the “less fair” lender would be like paying an 8.19-per-cent interest rate versus the 3.19 per cent. That’s astronomical. These days, determined mortgage shoppers do backflips to save even a 10th of a percentage point off their rate, let alone five whole points.

WAYS AROUND PENALTIES

Some big banks are kinder than others when it comes to helping you avoid prepayment pain. The better ones let you add money to your mortgage without penalty, offer early renewal options and have flexible portability rules.

But more often than not, you can find a similar mortgage from a fair-penalty lender for a comparable price or better – without the penalty shackles.

If you’re dead-set on a big-bank mortgage and want to lower your exposure to heinous fixed-rate penalties, consider a short-term fixed or variable rate instead – if it’s suitable for you. By suitable, I mean you have a tolerance for potentially higher rates sooner than five years and you have no problems getting approved for a mortgage.

These days, with so many people taking fixed rates because they’re cheaper than variable rates, banks stand to make a killing on prepayment charges. That’ll be especially true if recession hits and rates fall further. We come across people almost every week who’d love to refinance at today’s lower rates, but they can’t because their bank penalty is too harsh.

The time has come to heed this lesson as borrowers. Big-bank IRD penalties clearly overcompensate banks for the legitimate expenses they incur when a customer backs out of a mortgage early. The more that people demand fair penalties, the more pressure it’ll put on Canada’s six biggest lenders to change their methods.

Robert McLister
https://www.theglobeandmail.com/investing/personal-finance/household-finances/article-big-banks-prepayment-charges-give-reason-to-consider-fair-penalty/

Considering a reverse mortgage? Here’s what you need to know

General Tim Hill, MBA 5 Nov

While a conventional mortgage advances you funds in order to buy a house, a reverse mortgage is just the opposite: It advances you funds from the house you already own. In this era of declining pensions, increased longevity and costly long-term care, are reverse mortgages a godsend? Or are they another symptom of growing debt?

Photo created by freepik – www.freepik.com

More than ever, Canadians are turning relying on reverse mortgages—a “don’t-pay-till-you-die” option to create cash flow from the equity in your home—and the trend is turning conventional wisdom about debt and retirement on its head. While past generations fought hard to avoid debt in their golden years, data from the Office of the Superintendent of Financial Institutions (OSFI)—the federal government agency that supervises and regulates banks, insurance companies, and trust and loan companies—confirms that reverse mortgages are on the rise in Canada, with $3.78 billion in reverse mortgage debt outstanding in July 2019, just over 26.24% higher than the same month last year.

But given rising home values and rock-bottom interest rates, perhaps the conventional wisdom about reverse mortgages is due for an update. Are reverse mortgages a symbol of everything that’s wrong with Canada’s debt-obsessed citizenry, or a rational solution in an era of declining pensions, increased longevity and costly long-term care?

There’s a lot to consider, so this explainer will take you through the ins and outs of reverse mortgages.

How does a reverse mortgage work?

While a conventional mortgage advances you funds in order to buy a house, a reverse mortgage is just the opposite: It advances you funds from the house you already own.

Qualifying homeowners—who must be age 55 or older—can borrow up to 55% of the value of their home (depending on the home’s value and type, and the ages and genders of the borrowers). To maintain eligibility for the loan, the borrower must maintain and remain in the house as their principal residence, pay the property tax bills and keep valid insurance in place, but there are no restrictions on the use of the funds once they’re in your hands. If one spouse dies, the surviving spouse is not required to repay the loan, as reverse mortgages are not not “callable” (meaning, the lender cannot request repayment if the borrowing conditions are met).

When you’ve established a reverse mortgage, you receive funds tax-free either as a lump sum, or as regular monthly deposits. Interest accumulates on the loaned funds as they are received. The reverse mortgage becomes due when the last surviving owner dies, if the house is sold, or if the homeowner or homeowners move out of the home.

Today, there are two providers of reverse mortgages in Canada: HomeEquity Bank and Equitable Bank. (Seniors Money Canada, which came to the Canadian market from New Zealand in 2007, is no longer offering new loans.)

Equitable Bank’s reverse mortgage rate is 5.49% for a five-year fixed term, while HomeEquity’s rate is 5.59%. (Other rates, including variable options, are available as well.) If you’re thinking these rates are significantly higher than rates for regular mortgages—you’re right (and we’ll talk more about that in a moment).

How a reverse mortgage impacts your home equity

Reverse mortgages, second mortgages and home equity lines of credit (HELOCs) provide three different ways to create cash flow from a house you own. Of these three options, however, only the reverse mortgage does not require both income to qualify, and at least minimal monthly repayment during the borrowing term.

With a reverse mortgage, the existing home equity is used as security for the funds provided by the reverse mortgage. After the reverse mortgage is established, any future growth in the value of the house goes to the homeowner. (If the home falls in value, the reverse mortgage lender takes the loss—the lender guarantees that the borrower will never owe more than fair market value of the home.)

Calculating the impact of the reverse mortgage on home equity thus becomes a function of estimating the term of the loan, the home’s value at the end of that term and the interest payable on the advanced funds.

HomeEquity Bank provides two illustrations for a borrower whose house is worth $600,000 and who takes a reverse mortgage of $150,000 at current five-year rates of 5.59%, repaid after 15 years.

At a modest house appreciation rate of 2%, the homeowner has $450,000 in equity remaining when the reverse mortgage is established, and—due to housing price appreciation – is left with $451,826 in home equity after 15 years. In other words, the homeowner is—in nominal (not inflation-adjusted) terms—“no worse off” at the end of the reverse mortgage term as a result of borrowing from their home equity than they were at the start of the reverse mortgage term.

Using an appreciation rate of 5%, however, the homeowner’s equity grows to $891,662 over the same 15-year period—meaning, essentially, the homeowner’s equity doubles even as they remove $150,000 and pay $205,695 to service the borrowing costs.

2% annual appreciation 5% annual appreciation
Today In 15 years In 15 years
Home value $600,000 $807,521 $1,247,357
Reverse mortgage $150,000 $150,000 $150,000
Interest $0 $205,695 $205,695
Remaining home equity $450,000 $451,826 $891,662

Note: All figures provided by HomeEquity Bank, October 16, 2019. This example is for a lump-sum reverse mortgage with all funds advanced at the start of the 15-year term. 

Part of a bigger picture

The growth in reverse mortgages is part of a bigger picture of debt and housing wealth among Canada’s aging population. Statistics Canada data shows that debt for the over-65 crowd has increased sharply in recent years, with the proportion of indebted seniors growing by more than 50% from 1999 to 2016.

Over this period, the average increase in seniors’ debt was $50,000, of which fully 67% was mortgage debt. At the same time, however, the average increase in seniors’ assets was just over $500,000, of which 51.7% is attributable to real estate assets—meaning that seniors’ increased (mortgage) debt is, on average, moderated by their increased (real estate) assets.

HomeEquity Bank says their average customer is a 72-year-old who borrows $170,000 to pay down their debt and supplement their income. Reverse-mortgage funds could also be used to fund renovations that let you stay in your house longer, to help your child or grandchild with an “early inheritance,” to provide “bridge” financing if you wait to take Canada Pension Plan or Old Age Security benefits, or to pay for long-term care or long-term care insurance. And because the funds aren’t taxable when you get them, there’s no impact on government benefits that can be clawed back based on your taxable income, such as Old Age Security and the Guaranteed Income Supplement.

The future of reverse mortgages

The conventional wisdom on how to treat housing wealth in retirement has been to preserve it as a last-resort option, with reverse-mortgage lenders thus viewed as “lenders of last resort.” If housing wealth is not needed to help fund retirement, this view goes, the home can be left as part of the legacy for the next generation. As a result, it’s easy to find reverse-mortgage naysayers: former Minister of National Revenue Garth Turner famously quipped that reverse mortgages are “an ideal strategy, if you hate your children.”

The criticisms of reverse mortgages tend to focus on the rates, which are more than double comparable five-year mortgage rates (which might be as low as 2.5% today) and several percentage points higher than HELOC rates (which can be 3.75% and up).

Another focus of criticism is the overall indebtedness of seniors who may have few, if any, other options. This lack of options, however, is what puts reverse mortgages on the table in the first place: With lowered incomes in retirement, mortgages and HELOCs may be unavailable to many Canadians.

Simply selling the home to create the desired cash flow can present other problems, as the principal residence provides a source of tax-free compounding that is decreased by downsizing or eliminated by renting. As a result, a senior who wants to “age in place,” perhaps with the support of a reverse mortgage to cover home renovation or care costs, may find the reverse mortgage the best of their available options.

Looking backwards, the rise in reverse mortgages can be understood as Canadians’ collective response to lower costs of borrowing, gains in home equity, and reduced income security in retirement with the decrease in defined-benefit pensions.

Looking forward, whether you love ’em or hate ’em, with Canadians facing the need to cover the costs of retirement that may last well into our nineties and beyond, reverse mortgages may, in fact, be here to stay.

Alexandra Macqueen is a Certified Financial Planner and retirement expert providing advice through Pension Acuity Partners.

Considering a reverse mortgage? Here’s what you need to know