Quick Tips: Minding Your Credit

Canadians fall into two broad camps: those with good credit scores and those with scores below 680.

Those with sub-680 scores who are looking to buy a home either require a co-signer with good credit or a solid plan to lift their credit score above the magic 680 mark. Some lenders will accept lower credit scores, but that leniency is often paired with higher interest charges and/or upfront fees.

Poor credit scores often involve job loss, business failures, poor investments, poor health, divorce, easy access to credit cards and eventual bill payment neglect, all resulting in stress and the need for retaking control of personal finances.

For Generation Z and other Canadians new to credit, obtaining a first loan or credit card effectively means their every action and move in the credit market is being scrutinized. They enter the credit game where positive behaviour (paying bills on time and in full) is rewarded and negative behaviour (neglecting to pay minimums, delaying payments) puts the borrower on a path that may lead to future credit privileges being rescinded.

But there is good news: A sustained series of positive actions in time can restore credit scores to healthy levels. Here’s how the credit system works, how to maintain a high score and how to lift a low score higher.

High Score, Low Stress

Credit scores are assigned based on “predictive analytics,” a data science technique that mixes data mining, artificial intelligence, statistics and other types of analysis to predict behaviour.

The two major credit report providers in Canada are Equifax and TransUnion. Equifax Beacon Scores range from 300 to 900 (https://www.equifax.ca) with higher scores being more desirable. TransUnion’s Empirica Scores go as high as 850+. Lenders generally use a borrower’s credit history, FICO score (http://www.fico.com) and other information to calculate a credit score.

Here are some of the major determinants of a borrower’s credit score, with potential weightings:

1. Payment History (35%) If you are making your obligatory payments on time, excellent. If you have missed a payment, how long did it take for you to eventually pay? Thirty, 60, 90, 120 days or more? The longer a payment remains in arrears, the more detrimental the impact. Get back on track as soon as possible.
   
   
2. Credit Utilization (30%) Experts advise that you use no more than 30 percent of your available credit. On a credit card with a limit of $5,000, as a rule try keep the monthly balance below $1,500. That said, lenders need to see that you have a track record of taking on and paying off debt. Paying off the balance on your credit card or line of credit will strengthen your score as will a track record of on-time consistent mortgage payments.
   
   
3. New and Existing Credit (25%) Your account history can be used to predict future credit behaviour. Once you start applying for new credit, such as a mortgage loan, the mortgage agent will need your authorization to pull a credit report. The credit report request is considered a hard inquiry, which temporarily lowers your credit score. Seeking other types of credit, say a car loan at the same time will further lower your score. Being hungry for credit will work against you. However, credit report providers understand that when seeking a mortgage you may make several inquiries within a 30-day period. Those inquiries are considered one hard inquiry (https://www.fico.ca). It doesn’t have the negative impact that seeking diverse types of credit at the same time has on your score.
   
   
4. Type of Credit (10%) Having different types of credit can be positive. Having a car loan, mortgage and revolving line of credit -- if consistently paid on time -- enhances your credit score.

Improving Your Score

• If you have a credit score that is lower than 680, start with setting up automatic bill payments or pay your bills a few days before they are due to ensure they are received by due dates.
  
• Pay off credit card balances every month. If you can’t afford to pay down more than the minimum payment, consider getting a personal loan or using a credit line to pay off card balances. One or two credit cards is all most of us need.
  
• If you are struggling with bill payments, consider credit counselling or refinancing your home to consolidate debt.
  
• If you had the unfortunate circumstance of filing for a first bankruptcy, it will stay on your Equifax report for 6 years from the date of discharge and on a TransUnion report for 7 years in Ontario. You will have to rebuild your credit one on-time payment at a time. For a mortgage, you may need a private lender through a brokerage and/or may require a co-signer.
  
• Check your credit score twice a year. When you check, it is considered a soft inquiry and has no impact on your credit score. Ensure the information is correct as you can dispute details with proof. Simply contact Equifax or TransUnion.

Reference for images included in article: See Sample Credit Score from Equifax Canada.

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Susan Williams is a mortgage agent in Toronto with Mortgage Architects. For help you with all your mortgage and refinancing needs, email her at susan.williams@mortgagearchitects.ca.

What stricter mortgage rules mean for you

The Office of the Superintendent of Financial Institutions (OSFI) is drawing a line in the sand for anyone who applies for an uninsured mortgage in Canada in 2018: Qualify at the new restrictive standard or explore alternative options.

Here's what you need to know about the new mortgage stress test:

1. Takes effect January 1, 2018

2. Affects applicants for low ratio mortgages who are seeking to refinance or purchase and have home equity (or a down payment) of 20% or more.

3. Does not affect renewals with the same lender. If switching to another lender, the stress test will apply.

4. The 'stress test' aspect of the new rules comes in the form of higher qualifying rates. Here's how it works:

• Today's posted rate is 4.99%.
  
• An applicant may be able to secure a 5-year contractual fixed rate of 3.50%
  
• When the stress test is introduced, the applicant must qualify at the posted rate or the contractual 5-year fixed plus 2 percent, whichever is higher.
  
• For example, 4.99% posted rate or 3.50% + 2%. The applicant must qualify at 5.50%. He or she will be able to afford less house than under the previous rules. And some applicants will not qualify. They may need a co-signer. Or may seek a solution with an alternative lender through a mortgage broker.
  

5. Some lenders may allow applications that start in 2017 but are funded in 2018 to qualify via 2017 rules.

6. Applicants can lower their payments by choosing a longer amortization period such as 30 years or more at select lenders.

7. Credit unions may or may not adopt the new OSFI qualifying standards. Your mileage may vary.

Before Choosing Fixed, Consider a Hybrid Mortgage

A reader writes: “My wife is conservative and wants fixed, but I think going variable makes more sense. What mortgage option should we choose?”

When clients can’t decide between choosing a fixed or a variable rate mortgage, I often raise a pretty strong alternative that offers the best of both: “Have you considered splitting the mortgage into one part fixed and one part variable?”

According to industry association Mortgage Professionals Canada, about 4 per cent of mortgages are classed as ‘hybrid’ or ‘combination’ mortgages that may consist of fixed and variable components, or may split the mortgage into various term lengths. The hybrid option I recommend consists of a 50/50 split between fixed and variable.

With Canadians fearing additional rate hikes in the coming months and years, the shift in favour of fixed over variable is on, according to MoneySense magazine, citing data gathered from a rates web site. More than half are now opting to lock into fixed rates.

Here are five points to ponder when considering the hybrid mortgage option:

1. You get the predictability of a fixed rate and the savings of a variable rate. However, some experts believe the spread needs to be at least two percentage points to see significant benefits.

2. While interest rates are notoriously difficult to forecast, a hybrid 50/50 split can leave you with more mortgage principal paid down relative to interest in three scenarios over the next three to five years:

• rates increase slightly
  
• rates stay put, or
  
• rates decline

3. If rates increase substantially during that period, there is good news and bad news. The good news is that 50 per cent of your mortgage is locked into a fixed rate. The bad news? The remaining 50 per cent is exposed to rate fluctuations. An all-fixed option is best if you don’t have the financial flexibility or risk tolerance to deal with that exposure.

4. You may lock in the variable rate at any point. However, you will likely pay a three month interest penalty to do so and will have to negotiate the fixed rate.

5. Keep it simple. Make sure that both fixed and variable segments have the same term length – say 5 years – which gives you full flexibility to switch lenders once both terms expire.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada. Email: susan.williams@nbc.ca Twitter: @YMJourney

Online and instant – a look at e-mortgage trends

On the heels of Millennials will be a tech savvy, social media aware cohort known as Generation “Z". Born after 1997, Generation Z will be comfortable banking online, applying for mortgages via mobile apps all the while – at least according to Wikipedia -- being more risk averse in their outlook than previous generations.

When the time comes, will they routinely meet in person with a mortgage expert to get a home loan or home equity line of credit?

It seems that a purely digital mortgage application experience will inevitably become mainstream in the next 10 years as the oldest members of Generation Z turn 30.

Online and Instant

This summer, Australian fintech outfit Tic:Toc Home Loans (https://twitter.com/tictochome) announced, in partnership with Bendigo and Adelaide Bank, the world’s first instant home loan. The system can approve a loan in 22 minutes and provide competitive rates.

In Canada, the consumer isn’t the obstacle for change. As CMHC reports, “Almost half of mortgage consumers (48%) agree they would feel comfortable using more technology to arrange their next mortgage transaction.”

And in the United States, 62% of homebuyers under 35 would use their lender’s mobile app to apply for a mortgage if given the option, according to a JD Power Survey.

Digital and Hassle-Free

Two startups in the United Kingdom – Habito and Trussle -- are trying to gain market share by taking the mortgage advice and application process entirely digital. Habito claims to generate approvals seven times quicker compared to a traditional process involving a human broker while Trussle shrinks the time for a quote to three minutes, on average.

Habito guides customers through the virtual mortgage application using chatbot conversations. Salary, employment history and other personal information are gathered in order to assess a customer’s creditworthiness, speeding up approvals and cutting out human advisors.

Personal service in demand

Not everyone will welcome a digital focus. In the recent CMHC survey, “the majority of mortgage consumers agree that it is still important to meet face to face with their mortgage professional when negotiating (69%) and finalizing their mortgage (70%).”

Artificial Intelligence is changing the mortgage industry. Personal touch will give way to a more efficient user experience and 24/7 convenience. For better or worse.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada.
Email: susan.williams@nbc.ca Twitter: @YMJourney

Your rainy day funds may hold the key to mortgage approval

The 80/20 rule is alive and well in the land of mortgages. Roughly 80% of successful applicants qualify based on having enough income to cover their housing and other debts while the remaining 20% have modest reported income and instead qualify because they have liquid assets at their disposal in lieu of income.

Let's explore how fictional client Jeremy got approved using the funds he set aside for a rainy day.

Jeremy is a self-employed millennial, and also very smart. He's been scanning realtor.ca diligently for the past 6 months and pounced on a power-of-sale condo in North York, a rare find. But when I crunch the numbers, even after making his desired down payment of 35%, his debt service levels are still too high.

His Total Debt Servicing -- or percentage of income that pays for housing and other debts such as car loans and credit cards -- is 85%. Banks prefer the TDS to be 40% or lower.

Often, an out-of-whack debt servicing level can mean the end of an otherwise promising mortgage application. But, in Jeremy's case, he's got an ace up his sleeve in the form of liquid assets above and beyond his down payment.

How Jeremy's rainy day fund will get him approved

The standard way to get approved for a mortgage is to have a strong credit rating and enough income to easily cover the debt servicing of the mortgage, taxes, condo fees, heating and any other debts.

From the bank's perspective, Jeremy is an ideal candidate to qualify based on assets rather than income. He is currently renting and owns no other properties. The condo he is buying will be his principal residence. His T1 General shows an income of $50,000. Even better, after the downpayment he will have an $85,000 rainy day fund. His liquid assets will break down as follows:

• TFSA of $40,000
• Cash in a bank account of $15,000
• GIC of $30,000

Since these assets have been held for more than 90 days, from the bank's perspective they are part of Jeremy's tangible net worth.

Based on one bank's rainy day fund qualification criteria, Jeremy is well positioned to qualify for a mortgage if he has a good credit score plus substantial liquid assets. The calculation is as follows:

• Mortgage amount x 0.0065 x 36 months

Since Jeremy is requesting a $350,000 mortgage, the calculation is as follows:

$350,000 x 0.0065 x 36 = $81,900 He will require $81,900 in liquid assets in order to qualify for the mortgage. His rainy day fund of $85,000 means approval is a near certainty.

Other options

Given his strong financial position, Jeremy could use some or all of his $85,000 rainy day fund to do one or both of the following:

• Pay down current debt to get his debt service levels in line
• increase his down payment

However, he's happy leaving his rainy day fund intact, just in case.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada.
Email: susan.williams@nbc.ca Twitter: @YMJourney

Get your docs in a row before applying for a mortgage

Fictional couple John and Ishrat are in my office, determined to get a mortgage pre-approval letter. They end up receiving a mix of good news and bad news.

The good news is that, if the numbers they have provided are correct, they will be able to purchase a home for as much as $591,000. The bad news is that John, who is self-employed and works in construction, hasn't filed his income tax returns for three years.

John's homework is to play catch up, as the bank will need to reference some key documents in order to determine how much income to include in the mortgage pre-approval application.

The following documents are required as proof of income for self employed applicants:

• CRA notice of assessment for the most recent tax year
  
• T1 General for the two most recent tax years

Since they want to bid for a condo soon, John accepts that he has to move quickly.

Ishrat has changed jobs in the past year. She's working full time for an accounting firm. Since she has been working at a salaried position but has been with the company for less than two years, when she applies for the mortage she will need to provide the following:

• a letter from the employer
  
• the most recent paystub (or account showing 90 days of payroll deposits)
  
• most recent T4 or CRA notice of assessment for the most recent tax year

If Ishrat had been with the company for two years or more, she would require different documentation, as follows:

• the most recent paystub (or account showing 90 days of payroll deposits)
  
• most recent and previous year's T4 or CRA notice of assessment

I was able provide more good news. Ishrat's credit score is 710 and John's is 690. They will need to maintain or improve these scores going forward. Credit scores below 680 can be considered risky when applying for a mortgage. I advised them to not apply for any credit in the next few months and to keep paying all their bills early or on time. If both John and Ishrat had risky credit scores, they would likely need a co-signer.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada. Email: susan.williams@nbc.ca Twitter: @YMJourney

Profile of a CMHC insured borrower - second in a series

In part two in a series on insured mortgages, we begin with a profile of the average borrower who paid insurance premiums to Canada Mortgage and Housing Corporation (CMHC) on behalf of a mortgage lender when closing the purchase of a residential home in the first nine months of 2016.

All info was gleaned from CMHC's latest quarterly report ending September 30, 2016 and unless otherwise stated covers new loans originated during the first nine months of last year. Prices in the GTA have climbed to record highs since September, but despite a lag the data is still relevant in March, 2017.

From the above, you can see that the borrower is taking on a high ratio mortgage with a loan-to-value of about 92 per cent. The borrower's credit score is solid and the Gross Debt Service (GDS) ratio makes the borrower a low risk. GDS is often calculated as Principal + Interest + Taxes + Heat + half of Condo Fees / Gross Annual Income. CMHC typically will not insure loans if the borrower's GDS is above 35.

A more detailed review of the data from CMHC is shown below.

Mortgage Insurance Industry Overview

All high ratio mortgages where the downpayment is less than 20 per cent of the purchase price must be insured by CMHC or one of its private sector competitors such as Genworth MI Canada. The premiums protect the lender but are paid directly by the borrower. Some lenders may insist that even low ratio purchases be insured, as can be the case with seasonal properties or second homes.

To qualify for mortgage insurance, the purchase price of the property must be less than $1 million, the purchaser's Beacon credit score must equal or exceed 680, the mortgage amortization period will not exceed 25 years and the debt service levels must be in line with the lender's guidelines using a stress test interest rate (4.64% for 5-year fixed at the time of writing). As a rule of thumb, insurance premiums for CMHC and Genworth are similar, but Genworth may be a more viable option for purchasers who can't meet CMHC's tougher debt servicing criteria, are self-employed or are looking to buy a second home or multi-unit residential property.

While market share numbers vary over time, about one of every two insured mortgages in Canada is insured by CMHC, and as a result is fully backed by the Government of Canada. So CMHC is the biggest industry player. Genworth and other private sector players account for the remainder of the market. Mortgages insured by private sector insurers are also backed by the federal government, subject to a 10 per cent deductible, according to The Globe and Mail.

In its last reported quarter (ending Sept, 2016), CMHC reported net income exceeding $300 million and a miniscule arrears rate of 0.32 per cent. CMHC regularly runs stress tests of its portfolio vs. extremes in interest rate or loan default scenarios and passes unscathed. Similarly, Genworth's recent financial results read very well too: "On a full year basis, the Company reported net income of $417 million."

It's worthwhile noting that CMHC and Genworth Canada have both recently raised mortgage insurance premiums. The CMHC premium increases will result in an additional cost of about $5 per month for borrowers.

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Source: Mortgage Loan Insurance Business Supplement, Third Quarter, September 2016

Source: CMHC's 3rd Quarter Financial Report (2016) Media Briefing - November 29, 2016

Source: Financial Post: CMHC goes from insuring 90% of new mortgages to only 50% — and that’s as low as it plans to go

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Susan Williams is a Mortgage Development Manager with National Bank of Canada.
Email: susan.williams@nbc.ca Twitter: @YMJourney