Vet calls for mortgage qualification crackdown

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 It may not be a popular opinion, but one veteran broker argues there should be tougher standards for qualifying for a five-year fixed-rate mortgage.

“100% there should be tougher standards for qualifying for a five-year fixed rate; I’m in awe that they haven’t done it,” Calum Ross, principal broker of Verico Calum Ross Mortgage, told “With the Big Short movie out and everyone saying Canada is immune (to a similar downturn); I’m going to say the five-year qualifying rate is a disaster waiting to happen."

Clients taking a five-year mortgage rate can qualify at the contract rate. However, variable rate mortgages and fixed mortgages under five years typically require homebuyers to qualify at a higher “benchmark” rate.

Ross, who has both an undergraduate and an MBA in finance, argues many clients who currently qualify for a five-year fixed-rate would face potentially unsurmountable economic challenges if rates were to increase.

“You can put this in real terms: If that 1% interest rate increase is realized, that means five years from now my income would have to increase by 33% to maintain my current debt servicing numbers,” Ross said. “Real wage growth in every province is not above 3%. So you would have to be a statistical anomaly just to keep your head above water.”

Ross estimates that half of mortgage holders have a five-year fixed-rate mortgage product and many of them have maxed out their debt servicing numbers.
He argues even a 1% increase in interest rates could be difficult for these clients to handle.

“It’s unrealistic to think today’s interest rates are going to be around forever,” Ross said. “Five years from now if interest rates increase 1%, that’s a hell of a big pill for the average Canadian to swallow.”

Ross also argues the current qualification standards pose a risk to the industry.

“I worked in global treasury in London before working in the mortgage industry; I’ve taught finance at the MBA level. It’s unequivocally a risk,” he said. “I don’t think there is a risk; I know there is a risk. It’s just how much of a risk there is.”

Ross’ argument in favour of tougher qualification standards may not sit well with many brokers. When told this, he replied:

“In a perfect world I would be both respected and liked but, if I have to pick between being respected versus being liked, I will take being respected every time,” Ross said. “Anyone who doesn’t’ think the five-year qualifying rate is a disaster waiting to happen simply doesn’t’ understand credit capital markets or default risk.”
  • Mortgage Geek on 2016-03-18 9:06:02 AM

    100% agree with Callum Ross. Finally someone who is willing to say what many in this industry don't want the public hear.

  • William Gosewitz on 2016-03-18 9:17:41 AM

    i have been saying for almost 40 years that the GDS and TDS ratios make no sense. We have never asked the proper questions - what about budget based qualifications instead of a global ratio ?...a person with 3 children qualifies for the same money as someone with no children - that is just one of so many examples of the the cracks in the system - 40 year amortizations make sense - just need to make the qualification process more stringent . And what if someone refinances 2 years from now and has to qualify at the benchmark rate instead of the 5 year rate ...they may not qualify - sadly the regulators do not fully understand the process...that is my humble opinion.

  • David Pylyp on 2016-03-18 9:34:05 AM

    Yet buyers continue to qualify at the posted 5 year rate [of near 4%] and select the Variable rate option of 2.29% which really defeats this whole argument.

    Income levels to support the debt required are a financial reality. If the Math works...

  • Frank on 2016-03-18 9:55:21 AM

    The issues in Canada are not mortgage lending as the deliquency ratio's speak for themselves right now 3/10 of 1% is hardly something we need to be worried about and with mortgage rules as strict as they are now, that number may actually come down before it goes up. Its unsecured lending and car loans that need tighter regulations, they are responsible for the higher debt loads and if the system was tighter on those facets of lending, then a 1% increase in rates 5 years from now will not have the same impact as Calum says it will.

  • Kent on 2016-03-18 10:18:02 AM

    Again, this is a broad brush opinion. I would agree with Mr. Ross when the property cost is the national average or higher, but there are many variables and people in smaller communities would be punished because of what is happening in the larger metropolitan areas. Canada consists of many smaller cities and towns where property values are very low. An increase in rate wouldn't be overly detrimental in these cases.

  • Ron Butler on 2016-03-18 10:23:26 AM

    While I agree with Ross there is a fundamental risk in our distorted real estate marketplace; I don't see that it makes sense to lay it at the feet of qualifying a 5-year fixed rate mortgage at the contract rate.

    It needs to be understood that in all developed countries; mortgage policy is public policy. While there is a case to be made for employing a qualifying rate for short term or variable mortgages, if we insist on using an artificial qualifying rate on all mortgages we would have to adopt the American system of only providing 30 year fixed rate mortgages.

    My point is that in a democracy where 68% of households own their own homes, basic mortgage policy has to be understandable and rational to the whole group. While the minutiae of underwriting is mysterious to all of us; general rules must make sense to the public. Qualifying at the contract rate of a 5 - year fixed rate mortgage has been a fact of life in Canada for 75 years, it has served our country well and most bankers prefer this system to the 30 year product in the USA.

    Interest rates have bounced around quite a bit in the last 30 years and Canadian homeowners have always found a way to manage all of those fluctuations.

    I think our concerns about the future of the mortgage and housing markets should focus on foreign ownership, the not much discussed issue of foreign down payment, as well as predatory sales practises that are designed to turn the sale of homes into a kind of auction guaranteed to inspire irrational, emotional behavior.

    No, I don't think changing qualifying 5 - year fixed mortgages at the contract rate will change any of that.

  • Jim Thornton on 2016-03-18 10:27:11 AM

    I absolutely disagree. I'm not sure where Callum Ross is getting his math from. A 1% interest rate increase does not result in a need for a 33% increase in income. If you calculate a $250,000 mortgages @ 2.69% and the payments required are $1143/mth (25 years). Balance remaining at the end of the term is $212,398. If you then calculate this balance for 20 years with 3.69% rate, you end up with a payment of $1260/mth. The income required @ 35% GDS on the first term is $3265/mth, the income required on the second term is $3600/mth. This results in less than an 11% increase in income over 5 years. An income of $3265/mth compounded at an annual increase of only 2% works out to $3604/mth at the end of 5 years. The numbers are perfectly in line.

  • Tomas on 2016-03-18 10:27:23 AM

    Chicken Little.

    Banks continue to write the mortages, MBS gets sold. No problem now, or the next 10 yrs. Move along.

  • Foys on 2016-03-18 10:27:52 AM

    In the article it said that a 33% increase in wages would be needed to support just a 1% increase in the interest rate. This is not correct. the actual number is 11% increase over 5 years which is reasonable to assume.

    I am guessing that Calum was quoted wrong.

  • rob on 2016-03-18 10:56:38 AM

    what I would really respect is if Calum didn't write five year mortgages unless they met his concern for the ability to service at higher interest rates.

    That would have been a great question for the interview.

  • JGV on 2016-03-18 11:03:51 AM

    Make your calculation if you buy down the rate now...What will be the renewal rate if the client is not comming back?

  • Ad Lakhanpal,Mortgage Broker on 2016-03-18 11:29:00 AM

    I agree with the concern expressed by Calum without getting tangled up in too many numbers.
    The fact is that a person opting for a variable mortgage or for a term less than 5 years is expected to be able to afford a rate increase up to the benchmark of say 4.64%,for their own protection just in case the rates increase. The same idea should apply to a person opting for a 5 year term. This way, everyone including borrowers,banks and insurers are "protected" equally.

  • Mortgage.John on 2016-03-18 11:29:09 AM

    I hate to argue but I agree with the math wizards here! The 33% is completely false and I am not even convinced that 11% is altogether correct. I did a CBC interview at the time of the maximum 80% re-fi announcement, during that interview I complained that this would create open season for the banks to jump in with high interest credit card and Unsecured LOC debt. CBC in their fear of upsetting the advertising gravy train from the Big 5, edited that part out.

    Has anyone ever asked why we still use only 50% of condo fees, on applications? Surely we all know that, especially on new buildings, the maintenance fees will be increasing upwards of 30% in the 5 year term discussed here.

    On a much lighter note I clicked to read this piece because I thought there was a discussion about VETERINARIANS and their mortgages!

  • Mortgage Guy Geoff on 2016-03-18 11:53:26 AM

    All due respect Mr. Ross, but it seems to me that if we as Brokers are doing our jobs right then our clients will not be terribly impacted by natural changes (increases) in the market rates 5 years hence. We should not only be giving them a mortgage now, but also setting up a strategy with them to ensure their success going forward. Most importantly we should be in contact with them periodically throughout the 5 years to help them stay on track and/or address their changing circumstances. We do this right and market rates 5 years from now won't matter. Unless of course we see an albeit unrealistic doubling or tripling of rates in which case we'll all have way bigger financial problems then mortgage payment affordability.

  • Mortgage Geek on 2016-03-18 12:41:26 PM

    The math maybe off on Callum's estimation but let's not ignore the fact that everything else outside of the Mortgage payment is rising faster than incomes. Groceries up, Hydro up, property taxes are going up, home maintenance costs etc.... If your barely qualify using gross income ( would not be surprised to income tax rise either) then you run the risk of not meeting your obligations in the future with after tax income. As for unsecured lending, yes it's a problem. But, the problem is not the fault of the creditors. The individual needs to take responsibility for how they use their credit. If someone runs up their credit due to frivolous spending and then can't pay, that's their fault. In some cases people using unsecured credit to fill the income gap due to the rising cost of living. What i believe is the true issue is that current underwriting standards today need to evolve to more accuretly reflect the true cost of home ownership and the cost of living in today's ultra low interest rate world.

  • LanceH on 2016-03-18 12:48:56 PM

    I have to agree that A) the 33% is way out of whack. We all have mortgage calculators and know that just isn't correct, and B) I have to agree with Frank that the Default Rate is what one wants to watch. And when you take out the Self Employed's, who's income is more subject the wild swings, the rate is even lower.
    Studies have been done to see if ppl can weather a 1% increase in rates, and they came out ok. No reason to panic. And it's the cc debt that will get lopped off via Credit Counseling, not the house/mortgage.

  • Jim Thornton on 2016-03-18 1:14:34 PM

    Well, saying that studies have been done isn't really a good strategy either though. Studies were done in 2006-2007 with regards to the mortgages in the U.S. too. We all know how that turned out. The studies are only as good as the variables you use.

    It comes across to me that big volume brokers like the OP want to pick up market share. Posting things like this might get the legislators looking at it, make the changes, as a result the smaller guys leave the business and the larger guys pick up more market share.

    I'm not sure if that was his motivation behind it. But, when someone says they have an MBA and worked in London in the credit markets or whatever, they should really explain statements like 33% increase in income. If income increases by 2% per annum, that works out to roughly an 11% increase over 5 years.

    Formula for compounded returns:
    p (1 + i) ^ n

  • John Martin on 2016-03-18 4:11:30 PM

    Here we go again another collection of good human beings predicting this and that and that and this!
    As with all the other masses in this industry or some other industry who try to predict if this happens and or if that happens every five minutes. Forget it. Just get on with trying to do your best for the clients now today. Forget the imaginary crystal ball. It's not there. The moment should be priority that's all you have. Remember that. That is reality!

  • Hugo Deen on 2016-03-22 3:22:37 PM

    Calum made a pretty passionate statement about this, can he clarify if he was misquoted or there was an error in his calculations. As all above have proven, the numbers he is using are considerably off and to make such a bold comment about it he should be asked to back up his math.

  • Dustan Woodhouse on 2016-03-18 1:14:28 PM

    The reference to the Big Short is unfortunate as Canada is so very much not the USA.

    I elaborated on this a while back here;

    The bad math is really unfortunate.

    I believe the average CDN mortgage balance is now around $300,000.00 and a 1% hike 5 years from now results in a $126.18 payment increase assuming a 25yr AM to start, and a 20yr AM at renewal.

    1% hike = $126.18 payment increase.

    A client with a $50,000.00 per year income does not need a $16,500.00 raise to handle that.

    They likely do not need any raise at all to handle that increase.

    However even just a 0.75% raise per year will keep them neutral.

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