|An expansion on a piece published this week in Jurock’s Facts by Email www.jurock.com/insider|
|With mortgage arrears rates declining from already low levels I am often asked why lending guidelines have tightened as much as they have over the past 4 years.Short Version1. The more restrictive guidelines have effectively simulated interest rate hikes of between 1.5% and 3% depending on the clients application.2. The Federal Government has found a new way to drive unreported income into the light of day and thus increase tax revenues. Thus the huge focus on ‘documented income’ of business-for-self applicants.
Artifical rate increases.
With the Federal Government handcuffed by broader economic implications such as manufacturing, export, currency strength; jacking up interest rates simply to cool the housing sector was not an option. This is far to massive of hammer for the reasonably small adjustment required.
As such the Department of Finance supplied another tool with which to simulate an interest rate hike.
Mortgage lending guidelines.
An excellent example; reduction of available amortization. A 5 year reduction has the equivalent effect on the amount of money a client qualifies to borrow as does a .50% interest rate hike.
This is why we saw graduated steps from 40 yr, to 35yr, then to 30yr, and partially (for insured mortgages ONLY) a step for some to 25yr.
The equivalent of a 1% rate hike for conventional mortgages (20% down or more), and a 1.5% simulated interest rate hike for those putting less than 20% down on a purchase.
Factor in additional tightening on credit requirements and rental income calculations (basement suite & additional properties) and there is easily another equivalent of 1% – 1.5% of artificial rate hikes buried within the system.
Lets all hope that the Fed has their finger hovering over the ‘Undo’ button as and when interest rates do in fact start to climb. Equilibrium is important. It has been somewhat maintained on the way down, lets hope the same occurs on the way back up.
What about this income tax theory though?
Any retired, or self-employed (business owner) mortgage applicant of late will be acutely aware of the intensely detailed focus on the amount and origin of ‘Documented income’ being reported on their T1 General tax returns with regard to receiving mortgage or line of credit approval.
How dramatic a shift has this been?
Todays applicant may have stellar credit, an impeccable repayment history, along with a strong equity position or down payment (as much 50% even) – but that is just enough to get ones toes up to the finish line, not across it. The key ingredient these days is that magical ‘Line 150’ income as documented not just on the CRA Notice of Assessment, but also the composition on the T1 General tax return;
Get ready for complications, questions, and an uphill battle.
Why the dramatic shift?
It is plausible that an individual in the Federal Government came across what are known as ‘stated income’ mortgage lending programs a few years ago and then did some mathematics. (One should not confuse CDN stated income mortgages which required clean credit & significant equity with US versions, there is no comparison.)
Said mathematics, combined with the politically beneficial timing (optics of perceptions of the CDN market) of tightening mortgage lending guidelines and perhaps most importantly historic low rates which threatened to distort Canadians purchasing power, has led to the virtual elimination of these ‘equity lending’ programs designed primarily for ‘Business for self’ applicants – also caught in the mix are retirees who are finding all that hard won equity difficult to access (post retirement) for any purpose. Recent changes to these lending programs announced over the past few weeks by both Scotia Bank and Street Capital, driven by the OFSI’s B20 document of last fall, have made mortgage approvals for clients without clearly documented employment income significantly more difficult.
Running a cash business and declaring little income? No more easy mortgage financing for you. Now you must create a clear two year document taxable income average that matches closely the same debt servicing standards employees must meet.
The aforementioned ‘mathematics’ arguably are really focused on increasing taxable employment income from business owners.
A review of the billions of dollars of mortgages funded under these equity programs would result in a detailed look at the actual line 150 documented income of the applicants as opposed to the income figure ‘stated’ on the application.
The spread between factual and stated would likely would have been somewhat shocking to a tax collector. As an example of the disparity, there have been mortgage applicants with line 150 – documented income of less than $50,000, but stating an income in excess of $350,000.
At first blush this may seem a ridiculous stretch. However, upon deeper review of the file the lender sees that not only is the client putting $1 million of their own documented savings as down payment on a $3 million purchase, the applicant also has an additional $1 million in liquid assets, and several million more in real estate holdings, along with impeccable credit, and a very successful company operating for over 20 years at the same location with eight figure gross revenues.
Having taken significant income in previous years, the applicants need to draw significant personal income had dwindled to the point the client had taken $41,000 personally two years in a row as their documented income. Subsidizing the clients living standard was repayment of shareholders loans made years earlier. The return of the owners initial investment is common in later more successful years and often decreases the applicants need for a large salary. Legitimate circumstances.
In other words the potential to draw the required income clearly exists with this client, as such their is little risk to the bank. Most importantly the client has a significant amount of skin in the game, an excellent credit history, and lots of assets as back up.
As mentioned above, Canadian mortgage arrears remain at record lows, as such most lenders would love a client like the one outlined above.
However, the taxman is looking at a file in which it appears the client should have claimed an additional $300,000 of personal income to qualify for. The taxman is wondering where their cut of that income is.
It seems that a new approach has been found for the taxman to guide the self-employed to increase their documented, and taxable, income moving forward.
Be prepared, speak with your Broker.
Better yet, get your Accountant & your Mortgage Broker speaking with each other.