MORTGAGES: New mortgage rules target select few

The new mortgage rules coming into effect April 19 may make it tougher for some cashless couples to buy a house, but they have largely drawn a yawn from the real estate industry. The real target? Real estate investors, who will now have to come up with a 20% down payment to take on their next property or be forced to buy mortgage insurance.

Finance Minister Jim Flaherty said as much in announcing the changes. "The measures will not affect the ability of a Canadian family to buy a house. It will affect those who are speculating," Flaherty said. "What we're getting at is the speculation in multiple condominium units in particular which we see in Vancouver, Montreal, Toronto and in some other places in Canada."

Still, 20% shouldn't be a big deal to serious investors. Any investor who isn't putting that kind of skin in the game isn't playing the game properly, says Don Campbell, president of the Real Estate Investing Network, a Calgary-based association of investors who collectively own more than $3 billion in property.

But Campbell says there are more harmful changes buried by the headline-grabbing changes, particularly how the Canadian Mortgage Housing Corp. underwrites insured mortgages for income-generating residential properties.

Most major lenders typically use what is called an 80% offset to calculate whether someone can carry a mortgage on a rental property. Essentially, up to 80% of the expected rental income is used to offset the cost of the mortgage. Under the new rules, CMHC-backed loans will require banks to use a 50% add-back policy. That means half of the expected gross rental income will be added to an investor's income, but the entire mortgage is added to expenses. In other words, an investor's debt-service ratio will look much worse than before.

For example, consider someone who makes $50,000 a year in income, has an existing $1,000 mortgage on a principal mortgage and expects to received $1,000 a month in rent to offset the carrying costs of a new investment property. Under the new rules, income for calculating the debt-service ratio is $56,000, but monthly expenses are at least $2,000.

Under the old rules, the income would remain at $50,000, but expenses would only rise $200 to $1,200 – because 80% of the rent goes directly toward paying expenses – which means a better debt-service ratio.

Essentially, the new rules ignore the fact that rental income is typically used to pay off the rental property's mortgage and that change is significant, says Campbell. "As long as you were buying quality cash-flowing properties, not the speculative stuff, you were always making more every month than that 80%, so you could keep buying," Campbell says. "Now, even if you're cash-flowing like crazy, on paper in their formula you won't be."

And the more properties you intend to buy with CMHC financing, the worse your debt-service ratio will look. "It will be next to impossible to get approval using these new rules on your fourth rental property," Campbell says. "If they're only taking in 50% of the rent in their math, you're going to hit a brick wall where they say your debt-service ratio is above their threshold."

Campbell says the change doesn't just affect CMHC-insured mortgages by the banks. Mortgage-backed security lenders such as Street Capital, Merix and DLC Mortgages require that the mortgages in their portfolios also be insured, even if investors do have 20% down.

Campbell says investors would be wise to move their home mortgage to a less investor-friendly bank so that they're not using up their cap space (the total amount a bank is willing to lend to an investor) at a bank that is more investor friendly. Once the cap approaches the maximum, conventional financing is no longer an option because the banks will use the tougher CMHC rules.

There are also other minor differences between getting a mortgage for a residence and a rental property, says Anne Marie Froud, an Oakville, Ont.-based mortgage broker at Invis Inc. For example, some banks like to see that the property you're buying is leased, but that's less important if you can carry two mortgages on your own.

Most banks will also only allow investors to obtain fixed-rate mortgages, and sometimes only at a higher price. "If you're buying a home you can get 3.89%, but if you're buying a rental property most of the lenders will bump it up a quarter per cent," Froud says.

It's easy to see why banks are more careful with rental mortgages. After all, people are more likely to walk away from an investment property than their own home if they get into trouble. And, as Campbell points out, only 4% of all mortgages are for rental properties, but 70% of the fraud, foreclosures and defaults come out from that segment.

Still interested in buying investment property? Consider commercial property or multi-family buildings since CMHC will continue to allow people to have just 15% down, providing the cash flow warrants it.

(prepared by Andy Holloway/Financial Post/National Post)