In light of the past six months of COVID-19-triggered uncertainty, home sales in Canada have been shockingly brisk as a combination of FOMO and low interest rates keep drawing buyers into the market. The feeding frenzy won’t last – plenty of organizations are expecting a major correction in the coming months – but waiting until it passes may not be the best course of action according to one mortgage insider.
In his recent dealings with clients seeking preapprovals, Alex Leduc, who does double duty as both Mortguage’s principal broker and its CEO, came to notice what could be a chilling trend for Canadians with variable incomes. Faced with earning a significantly lower income in 2020 because of pandemic-related busines disruption, this particular cohort of prospective buyers – hourly wage earners, the self-employed, anyone whose income depends heavily on bonuses or commissions – could see their buying power plummet – until 2023.
“It’s not necessarily just homebuyers,” Leduc says. “It would be anybody who is buying, or even potentially switching mortgages, who has a variable form of income that would be effected.”
When lenders evaluate borrowers with variable incomes, Leduc explains, they look at notices of assessment, T4s, and T1s for the two most recent years and calculate the average between them. The lesser of the two-year average and the most current year’s income becomes a person’s qualifying income. Anyone buying in 2020 will use 2018 and 2019’s records – no problem there – but buyers who wait until 2021 will be evaluated using 2020 income levels. For a significant portion of the population that experienced a disruption in income this year, that means less buying power.
“As of now, lenders are not going to use your 2020 NOA or T4 because you don’t have it yet. But once you have it, you have to use it,” Leduc says.
In a recent blog post, Leduc provided an example that highlights the potential problem: A buyer earned $96,000 in 2018 and 2019, meaning her two-year average qualifying income this year is also $96,000. But if her 2020 income falls to $80,000, much lower than the two-year 2019-20 average of $88,000, that becomes her qualifying income for 2021. Leduc calculates that this borrower would see a 16 percent reduction, equivalent to around $74,000, in purchasing power.
Because lenders require two years’ worth of records, the problem will persist until borrowers get their hands on 2022’s financial docs. In 2022, borrowers will still be hampered by their 2020 earnings. It won’t be until 2023, when 2021’s and 2022’s earnings are taken into consideration, when these buyers might see their buying power return to today’s levels.
“It really does have a significant impact,” Leduc says.
With 2020 being the nightmare it is, some may wonder if lenders will adjust their metrics and attribute any loss in income to the pandemic rather than to borrowers themselves. Leduc doesn’t currently see much of an appetite for such changes among lenders.
“Some lenders are pretty cut-throat about it. A lot of them don’t sway from policy,” he says. “No one’s come out and said, ‘We’re going to make policy changes or exceptions to this.’ It’s really business as usual.”
He does, however, see a scenario where, if an abundance of Canadians see their buying power evaporate next year, lenders feel pressured to change their income calculations. If that happens, he says, they could decide, when looking at 2019-20 or 2020-21 earnings, to use whichever is higher to determine qualifying income. They could also potentially look at the past three years and use the two highest incomes to calculate an average.
Leduc insists that he’s not trying to generate panic. Plenty of Canadians with variable earnings will still be able to qualify next year and the year after. That’s why it’s important for them to sit down with their mortgage brokers now and start running a few possible scenarios. Leduc says he is working with his clients to ensure they understand the situation and can set reasonable expectations.
With a potential price correction on the way, buyers may feel safe waiting, thinking that even if their income for 2020 falls, a mini housing crash may help compensate for a shortfall in qualifying income.
That’s not a strategy Leduc encourages. Pointing to the example of the buyer whose purchasing power fell 16 percent, he says, “Even if we had price decreases, I don’t think it would be to the extent of 16 percent within a year. That would be pretty aggressive, I think.”