Oct 292012
 

There are certain lending rules that banks are expected to follow when they approve someone for a mortgage.

In Canada, the lending rules are…
1) No more than 32% of our gross income can go towards housing related expenses like mortgage, heating, property tax, etc..
2) No more than 40% of our gross income can to towards making payments for all our debts

Mortgage brokers and banks have these rules to protect themselves from risky borrowers. They use it as a standard to evaluate potential clients across the country. But we should not be relying on these guidelines to determine how much house we should buy. What really matters when deciding the size of our mortgage is looking at our complete financial situation and figuring out how a home fits into our long term financial plan. All that means is taking some time to look over our income, expenses, and future goals. We don’t need a detailed financial strategy or analyze every penny. We just have to be realistic.

Consider the 2 different households below.

The Dubois family lives in Quebec, has 2 children, a stay at home mom, 2 large dogs, and a husband who makes $100,000 a year with no pension plan. After income tax, the Dubois family only takes home about $67,000 for all their living expenses. According the lending guidelines, this family can probably be approved for a $400,000 mortgage.  But in reality they would be house poor if they bought that kind of home and they wouldn’t be able to save enough to meet their retirement goals. Poor Dubois.

On the other hand the Johnson couple lives in Alberta, don’t plan to have any kids or pets, both have stable jobs making $50,000 a year each, with defined benefit pension plans. Based on the same lending rules, they also qualify for a $400,000 mortgage. But unlike the Dubois, this couple takes home $80,000 of combined disposable income after taxes. And with presumably lower expenses than a family of four, it should be much easier for Mr. and Mrs. Johnson to finance that same mortgage.

By painting everyone with the same brush, these lending rules just aren’t very practical. That’s why they should be viewed as guidelines only. Banks are not in the business of looking out for our best financial interests. That’s why it’s up to us to plan for our own families. Instead of asking right from the start “This is my current income, how much can I borrow?..” we should instead be thinking “Here’s my entire financial situation including a savings plan. This is where I want to be a few years from now. What is the appropriate mortgage I should be taking on?” Once we know this we can then find out if our interests are within the mortgage lending rules :D

The good news is some banks are willing to bend the rules a little bit. When I bought my apartment in 2009, 37% of my gross income was going towards housing expenses, which is over the 32% limit. I just had to explain to them how despite my high ratio, I can still save over $1,000 a month because my other living expenses are relatively low. But without making a budget and financial plan first I wouldn’t have gotten them to make an exception for me :) Back then I was making about $40,000 a year. Just goes to show, Vancouver real estate is not too expensive and almost anyone who has a job can afford to buy a home here, as long as they take the necessary steps.

 

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  22 Responses to “Mortgage Lending Rules”

  1. I worked as a sub prime mortgage advisor briefly, and then when the financial crash of 2008 happened I was made redundant. I remember at the time, thinking some of this underwriting criteria is far too loose. Perhaps, as you did, banks should take a much closer look at people’s finances before making a decision. If anything, looking at how you spend your money is likely to indicate how well you’d cope with a mortgage and whether you are likely to encounter debt problems.
    It might seem overly intrusive, but a failing mortgage is in nobody’s interest.

    • Cool, that means you were in the industry :0) no wonder you know so much about interest rates. Mortgage defaults are the worst. I’m not too familiar with the UK, but the US still hasn’t recovered from the whole subprime mortgage crisis that started about 5 years ago.

      • We’re still having problems, but we haven’t been hit by a huge number of defaults…yet.
        The UK base rate has dropped to the lowest rate ever – 0.5% so mortgages are actually very cheap – that is if you can get one. Banks are so risk averse now they generally want at least a 20% deposit, so if you’re a first time buyer, you either need a very well paid job, help from parents or you can forget it. Basically our housing market is completely stagnant with a lot of people locked in to their homes with negative equity who can’t afford to drop their prices and a shrinking pool of buyers with the means to actually make a purchase. I guess with time the economy will start to improve and as people pay down their mortgage they’ll gain some equity, the danger is if interest rates increase dramatically many people may find their mortgage payments suddenly become unaffordable. Fortunately for me, I’ve been lucky enough to do the right thing at the right time and am sitting pretty regardless of what happens :)

  2. I agree that “we” need to look out for our own interests. When I hear someone say they are house hunting and the bank is lending them x amount and they say they are spending x amount I’m not shocked that Canadians rely solely on what someone says to them without looking into their own finances. Although we look up to the professionals and we should, when it comes to the money we earned. Run all the numbers and make sure the budget can balance with a thought out plan. No plan can equal disaster. Great post. Mr.CBB

    • You hit the nail on the head. People’s confidence are often misplaced because they think a mortgage specialist knows more about how they should budget their money than they do. Only the individual knows what he or she wants. It gets even worse sometimes when people don’t even know themselves what they really want to do with their money.

  3. Interesting post. Was it less expensive in Vancouver in 2009 or about the same as now? In any case, it does give me hope that I can also buy something here eventually!

    • It was less expensive in 2009. I purchased my 2 bedroom condo for $230K. Even though prices are 10% to 20% higher now I’m pretty sure there are decent 2, or even 3, bedroom apartments that are going for around $400K in today’s market. Detached houses on the other hand, that’s a different story lol.

  4. Ah les Dubois! Good call on making the distinction between the tax differences of the two polar opposite provinces ;)

    If I’m not mistaken, you can ask the bank to look over your finances. However, in our commission-based banking system, there’s a bit of moral hazard n’est ce pas?

  5. Never over extend yourself in a mortgage. Buy what you can afford or else you’ll end up always trying to paying off your debts to the bank and paying tons in interest. I heard some couples making average income with million dollar houses. You’ll be surprised how lenient some banks are when you have a 25% down payment or how rich your parents are lol.

    • The things bankers will do to make money surprises me at times. 25% downpayments and rich parents are partly to blame for shoddy lending practices. It’s their own children who have to make the monthly payments. Parents who help their kids buy million dollar houses are just making it harder on their children when they’ll be stretched to their limits with their average income jobs.

  6. I’m glad someone finally agrees that you can actually buy in and around Vancouver and not go broke. The fact that they got rid of 30 year mortgages makes it more difficult, however as long as you don’t expect a multi bedroom flat, buying is very do able.

    • I was lucky to get my mortgage when they still allowed for 35 year mortgages, lol. It feels like prices are dropping now around here. Soon I think it would be a good time to buy for anyone who is renting and don’t already own a home.

  7. Interesting. I wonder what the rates are in U.S. and how many people actually consider their retirement savings when applying for a mortgage. I wish I knew all of this before my mom got herself into a huge mess and had to be forclosed on. Ughh..

    • Rates are probably fairly low in the US as well. The good news for the economy is housing prices there appears to have hit a bottom and most areas are now seeing increasing home prices again.

  8. You’d think that bankers would realize the value in a repeat customer. It seems many are more worried about eeking out an extra dollar today rather than the five they might get from the awesome referrals they’d receive from a great customer.

    • That’s especially true if they know the inevitable collapse is coming so they want to make the big bucks and run off with the money while they can. Not a very good long term relationship model lol.

  9. These guidelines seem appropriate as a general rule of thumb but it’s definitely a good idea to calculate what you can afford. My mortgage and housing expenses are over 50% of my take home pay but I have a roomate and I max out all my retirement accounts so my situation is a little different.

    • That’s quite a unique situation you’re in. My housing expenses are lower than 50% of my net pay but it’s over 60% of all my expenses at the same time :0) I like how every month I am working away at my principle which reduces mortgage interest for the next month.

  10. Canada has been pretty good with its overall lending rules, but common sense dictates many people are overextended in their mortgages. My solution is to simply love living rurally! On a starting teacher’s salary my mortgages payments were about 28% of my net income. When my significant other starts work next year (also as a teacher) and then the payments will be about 10% of our combined income (on a 25 year amortization) which is a pretty sweet deal in my books.

    • That sounds so affordable. I’m thinking about retiring in a rural area in the next 20 or 30 years. It’s not only cheaper, but you also get the peace and quite.

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