B-20 - Those Other Mortgage Rules
Much discussion and media coverage over the last few years has been devoted to the rules governing insured mortgages. Since October of 2008, the Ministry of Finance has tightened these rules 4 times, most recently in July of last year. The cumulative effect of these changes is as follows:
- 100% financing no longer available (minimum 5% down payment required)
- Reduction in maximum amortization to 25 years
- Increase in the qualifying rate for variable terms and terms shorter than 5 years
- Elimination of mortgage insurance for secured lines of credit
- Stricter debt service calculations
- Elimination of mortgage insurance for homes over 1 million dollars
- 20% down payment requirement for rental properties
- Reduction in maximum loan to value on a refinance to 80%
But these aren’t the only new rules changing the way that mortgages are underwritten and approved. Around the time that the last of the insured mortgage rule changes came into effect, the Office of the Superintendent of Financial Institutions (OSFI) issued Guideline B-20 - Residential Mortgage Underwriting Practices and Procedures, commonly referred to simply as B-20. They didn’t receive the same fanfare and attention as the insured mortgage rules we all know and love, but they have had a significant effect on how lenders qualify borrowers and approve mortgages.
Who Does B-20 Apply To?
The B-20 guidelines apply to all federally-regulated financial institutions (FRFIs) “engaged in residential mortgage underwriting and/or the acquisition of residential mortgage loan assets”. Further, they apply to all mortgages issued by FRFIs, not just those subject to CMHC insurance. Although provincially regulated credit unions are not subject to B-20 many have put similar guidleins in place. Compliance was expected by no later than fiscal year-end of 2012, so implementation of B-20 is now in full effect.
Basic Principals of B-20:
The B-20 guidelines set out 5 fundamental principles intended to ensure “sound residential mortgage underwriting”. According to these principles FRFIs should:
- have a comprehensive Residential Mortgage Underwriting Policy;
- perform reasonable due diligence to record and assess the borrower’s identity, background and demonstrated willingness to service his/her debt obligations;
- adequately assess the borrower’s capacity to service his/her debt;
- have sound collateral management and appraisal processes to ensure the value and quality of the property; and
- have effective credit and counterparty risk management practices and procedures.
OK But What Does That Really Mean?
Although B-20 will have some effect on most borrowers (e.g. increased documentation requirements, lower permitted maximum mortgage amount) the effects of B-20 will be most strongly felt by self-employed borrowers and those seeking “non-conforming mortgages”.
Self-Employed Borrowers: Prior to B-20, it was possible for a self-employed borrower with excellent credit to obtain a mortgage with as little as 10% down, without providing proof of income. Provided the income claimed was “reasonable” in the eyes of the lender and the business had been in operation for the minimum required time, no further income documentation was required. These “Stated Income” or “Low Doc” mortgages have all but disappeared under B-20.
All self-employed borrowers are now required to back up their income, which is not always easy, particularly for incorporated businesses where funds may be kept in the corporation and expenses and income arranged in the most tax friendly manner. The inability to provide sufficient documentation could put such borrowers into the “non-conforming” category (see below), requiring a much larger down payment and potentially resulting in a higher rate.
Maximum LTV of 65% for Non-Conforming Mortgages: B-20 sets out a maximum loan to value of 65% for "non-conforming mortgages." Although no definition is given and the guidelines acknowledge that it will vary from lender to lender, “non-conforming” generally includes “non-income qualifying loans, loans to those with low credit scores or high debt serviceability ratios” or where the property itself carries elevated credit risk.
Banks and other Prime lenders generally didn’t approve such deals before B-20 but there were some good options with alternative lenders, some of whom would offer mortgages up to 80% or even 85% for borrowers who didn’t quite meet the banks’ stricter guidelines. Many of these mortgages will now be considered “non-conforming” and borrowers may need to turn to more expensive private mortgages to obtain financing above 65% of the value of their homes.
Debt Service Guidelines for all Mortgages: Some FRFIs who provided “non-conforming” mortgages did not always have stated debt service guidelines, taking a more flexible approach and looking at the deal as a whole. B-20 now expects debt service guidelines to be part of each lender’s underwriting policies for all mortgages. As with the 65% cap on non-conforming mortgages, this may push some borrowers into more expensive private loans.
No More Cash-Back Down Payments. Despite the requirement for a 5% down payment that has been in effect for several years, some lenders were offering 5% cash-back (to credit worthy borrowers) which could be used for a down payment (a bit of an end run around the 5% requirement). B-20 puts a stop to this, stating “[i]ncentive and rebate payments (i.e., “cash back”) should not be considered part of the down payment.”
Qualifying Rates For all Mortgages: One of the changes to the insured mortgage rules over the past few years is the requirement that a borrower applying for a variable rate mortgage or a mortgage with a term of less than 5 years be qualified at the greater of the rate in the mortgage or the Bank of Canada Benchmark Rate (typically just over 2% higher than Prime). Under B-20 this requirement has now been imposed on uninsured mortgages as well.
More Onerous Calculation for Other Debts: When determining how much mortgage a borrower can afford, lenders look not just at the monthly mortgage payments but other property costs and debts (taxes, heating, credit cards, car payments etc.). Under B-20, many lenders now look not just at what you owe but how much you could owe. For example, a borrower may have a secured line of credit with a $0 balance but a $50,000 limit. Despite the fact that there is nothing owing lenders may now impute a monthly payment amount and include this in the debt service calculations. Similarly, on other revolving credit facilities such as credit cards, lenders are now less willing accept the actual minimum monthly payment but will instead impute a higher monthly amount, typically 3% of the balance. Each of these practices can have a significant impact on the amount of mortgage a borrower will qualify for.
Maximum LTV for HELOCs Lowered to 65%: Home Equity Lines of Credit are now limited to a maximum of 65% of the value of a property, although the total loan to value of a HELOC combined with another standard mortgage can go as high as 80%. For example a borrower with a home worth $500,000 can have a $200,000 first mortgage and a $200,000 HELOC, but cannot have a $400,000 HELOC alone.
To summarize, unless you are a long time salaried employee with excellent credit, a 20% down payment and no other debts applying for a fixed rate mortgage of 5 years or more, it is likely that B-20 (combined with the new insured mortgage rules) will impact your qualification for a mortgage.
For further information on B-20 please see the following links:
Guideline B-20 - Residential Mortgage Underwriting Practices and Procedures
Canadian Mortgage Trends - OSFI Toughens Mortgage Underwriting
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John Freeland Smith