Pre-approvals Should be Illegal in Canada

pre-approved

CONTRIBUTED BY ELAN WEINTRAUB http://mortgageoutlet.ca/blog

Mortgage Rant #1: Pre-approvals should be illegal in Canada

Lately, I’ve been getting panicked calls from real estate buyers (or their Realtors) to inform me that their bank was not honouring their mortgage “pre-approval”.  Obviously, this creates tremendous stress for the buyer and Realtor, and this situation is becoming more and more common.

Why is this happening? 

It’s simple.  There is a huge misconception about what a “pre-approval” means.  Most Canadians (and Realtors) know that you should get pre-approved before making an offer to purchase real estate, but they believe the pre-approval means the banks is guaranteeing a mortgage, and nothing can be further from the truth.

So what is a pre-approval?

A pre-approval is basically an interest-rate hold, meaning that you applied for a mortgage, and the bank will honour the current mortgage rate for a few months.  Perhaps they quickly reviewed your application to check if you’re employed, or they briefly checked your credit, but not always.

So why does a pre-approval fail? 

Generally, a pre-approval is rejected when the income documents submitted did not match the application, or when the property has ‘problems’.  And this is happening more and more often.

Why are income documents failing?  Twenty years ago, a married couple might have purchased a house and the husband was a teacher and the wife was an accountant, and each made $50K per year and they’ve been working at their jobs for 10 years.  Easy, breezy.  Today, many borrowers have complex income situations.  For example, a borrower might rent out his basement, or paint houses (for cash!) on weekends, or work a lot of overtime, or have a full-time and additional part-time job.  So when he says he makes $100,000, he is not lying.  He is working hard and has several jobs because he knows real estate is expensive.  And he did the right thing – he got a pre-approval.  But, banks don’t think the way that we do, and they’ll want a consistent track record of that income.  So his income from painting cannot be included, because he’s getting paid in cash and he’s only been doing that for 9 months.  And his basement apartment isn’t a “legal” unit, and he’s not declaring it on his taxes.  Plus, he works a lot of overtime, but the overtime isn’t guaranteed.  So, according to the bank and his paperwork, his income is only $35,000.  Now this discrepancy could have been identified earlier on, if the mortgage application was reviewed by a mortgage professional with a detailed understanding of lender policies, but this is rarely the case, and the borrower who had a pre-approval for $500,000 based on his $100,000 income can now only qualify for a mortgage of $150,000 based on his $35,000 income.  Uh oh.  Now this person might be eligible for a mortgage from a different bank, but the interest rates may be much higher, because he needs a lender that will look at income beyond their tax returns…

Believe it or not, this issue can surprise wealthy borrowers too.  Imagine a doctor, accountant, lawyer who incorporates their business, but pays themselves a low salary to minimize taxes.  They might “earn” $500,000 and include this on their application, but many lenders will only look at their income on their personal tax returns which would be substantially lower.

But this isn’t the end of the story…

Pre-approvals are also failing due to issues related to the property.  The most common issue is the appraised value.  If you made an offer of $700,000 and the appraiser assessed the value at $600,000 – then the bank will not give you a mortgage based on the purchase price – it will be based on the $600,000 valuation – and the borrower will need to come up with an extra $100,000 in addition to the down payment.  Yikes.  Many buyers who purchased a property in Toronto in March/April but ordered the appraisal in July are in trouble – a good mortgage professional will try to appraise the property as quickly as possible to mitigate the risk of market timing.

But this isn’t the only reason that properties fail.  Many of you have heard of condos where the windows/balconies are falling out – which will likely lead to lawsuits, special assessments and issues of marketability.  I wouldn’t want to lend someone 95% on a condo where the building has issues, would you?  Other issues include hotel/condo hybrids, which many lenders avoid.  After all, there could be some monkey-business between how the hotel accounts for common expenses versus the condo corporation.  Other areas to be aware of are co-op apartments, or condos with lawsuits or underfunded reserve funds, and of course grow-ops and drug labs.  Oh, and here is a cool secret.  Believe it or not, some lenders have a “blacklist” for condos they will not lend on.  If your condo is on a blacklist, then it will be difficult to get a mortgage.  And this blacklist is not published, but it exists!  (It’s also not called a blacklist for legal reasons J)

What about freehold properties? They can fail too… If you are pre-approved, but you bought a house that was a marijuana grow operation, it is unlikely the bank will honour the pre-approval.  Mortgages can fail also if the house is not in ‘livable’ condition (ie mold, leaky basement, etc) or has structural or environmental issues (UFFI, Kitec plumbing, knob-and-tube wiring, asbestos, the list goes on-and-on!)

Another way a pre-approval can fail is an insufficient or ambiguous source of the down payment, driven by anti-money laundering laws.  Everyone knows that you “only need 5% down” to purchase a property, but this is false.  First of all, this is only for well-qualified applications.  Second, the maximum purchase price is $999,999.  Third, the down payment requirement is actually 5% on the first $500,000 and 10% on the next $499,999.  So if your purchase price is $999,999 – you need 7.5% down.  Plus, and most importantly… You also need have the closing costs, which could include costly land transfer taxes and other fees!  This might lead you to “borrow” some money from a friend or a credit card, but the bank will quickly ask you for the source of that “$10,000 last-minute deposit”, and if the source is unclear or not a direct gift from family, they will assume the deposit is a loan or cancel the mortgage entirely…

Finally, a pre-approval can be rejected if the situation of the borrower changed since the application.  For example, if you quit your job to start a business, or even if you quit and found a better job and you’re on probation, you might have a problem.  And good luck to you if you leased/financed a car, co-signed another loan or applied for new credit!

In summary, and very simply, pre-approvals should be illegal in Canada, because they give consumers a false sense of security to purchase the largest investment in their entire life.  Many Canadians have been burned by this advertising lingo, and it needs to change to add transparency and to inform and protect consumers.

What’s the solution?

The solution to this problem is simple.  Lenders need to change the terminology and call this process a “Simple Rate Hold”, because it accurately depicts the essence of the document.  Otherwise, they should clearly document the common methods that a pre-approval can fail, so that buyers make their decision with eyes-wide-open.

The next question is, how does someone avoid issues with a pre-approval?  First of all, I recommend ensuring your income documents are properly reviewed by a qualified mortgage professional – not a part-time “order taker”.  And when you provide your application, don’t “forget” to tell your mortgage professional that you own another property or that you’re about to lease a car – as they will find out and then your mortgage could be revoked!  Second, be aware of the limitations of a pre-approval.  It is not a guarantee at all, so do your due diligence.  Finally, where possible, make the offer conditional on financing.  A condition on financing was impossible in the spring, but sellers are much more willing to accept a condition in the slower market today.

Thanks for reading this contribution, stay tuned for more mortgage rants – and feel free to share this with your friends and colleagues.

Elan Weintraub earned his BBA and MBA from the Schulich School of Business, where he graduated in the top 3% of his graduating class.   He is a director and mortgage broker at Mortgage Outlet, one of the “Top 75 Mortgage Brokerages in Canada” according to Canadian Mortgage Professional Magazine.  Elan has delivered numerous mortgage seminars at the Toronto Real Estate Board, real estate brokerages and to investor clients and works with clients ranging from first-time buyers to new-to-Canada to bruised credit to sophisticated investors and commercial/construction projects.

Posted in Uncategorized

Mortgage Insurance Premium Hike: What You Need to Know

CMHC LogoThe CMHC announced today that it will be raising it’s mortgage insurance premiums effect March 17, 2017.

Here are some things you need to know:

Who will this affect?

This rate hike will affect those that apply for mortgage default insurance AFTER March 17, 2017. The key takeaway here is that if you can apply for your insurance before this date and get approved, you’ll still be able to pay the old rates. This rate hike will likely also affect the general rate pricing in the market, as some lenders whose business models rely on bulk insuring conventional (more than 20% down) mortgages will have to pay higher rates and will have to pass those costs onto their customers like we have seen in recent months since the October 2016 Regulations came into effect.

What the hike looks like:

Loan-to-Value Ratio Standard Premium (Current) Standard Premium (Effective March 17, 2017)
Up to and including 65% 0.60% 0.60%
Up to and including 75% 0.75% 1.70%
Up to and including 80% 1.25% 2.40%
Up to and including 85% 1.80% 2.80%
Up to and including 90% 2.40% 3.10%
Up to and including 95% 3.60% 4.00%
90.01% to 95% – Non-Traditional Down Payment 3.85% 4.50%

The CMHC changes will affect the market as a whole, and its safe to assume the other mortgage insurers will follow suit in the coming months. This is yet another measure to cool down the housing market and reduce the risks that Canadian taxpayers have to foot the bill for the Crown-owned CMHC’s losses due to a housing collapse.

Source: https://www.cmhc-schl.gc.ca/en/corp/nero/nere/2017/2017-01-17-0830.cfm

Posted in Borrowing, Credit, Insurance, Leverage, Mortgages

What They Won’t Tell You About Your RRSP

rrsp-bank

I frequently read finance blogs and respond to comments and posts around the internet to deepen my knowledge of personal finance in the Canadian context. I recently came across a paper that proved my (a finance professional!) conception of the benefits of an RRSP to be completely flawed. In fact this groundbreaking paper challenges the conventional wisdom that your financial advisor will use to persuade you to contribute to your RRSP in the months and weeks leading up to March 1, 2017. One comment in particular that resonated with me was the universal assumption that Canadians stand to benefit from a lower tax bracket at withdrawal time for the RRSP. If you are going to be in an equal or higher tax bracket the benefits of the RRSP will be minimal or could even be losses compared to other investment avenues. My father once asked me a question I’ll pose to you: DO YOU PLAN ON EARNING LESS IN RETIREMENT?

The paper is about 10 pages long and a very good read for anyone considering making a contribution this year. I have listed the conclusions of the paper below but encourage you to read it here

Common benefits and assumptions listed by finance professionals, banks, Investopedia and even the CRA:

  1. The tax deduction on contribution – you pay less tax
  2. Profits are tax deferred – not taxed at the time but taxed on withdrawal
  3. The deferral of taxes on the original wages – the benefit of paying tomorrow versus today
  4. A lower tax rate on withdrawal than at contribution

The TRUTH!

  1. The tax deduction is not a benefit and the savings at contribution eventually fund the taxes at withdrawal
  2. Profits earned in the RRSP are in fact never taxed. The withdrawal taxes are an allocation of principal, not a tax on profits
  3. There is no benefit from deferring the taxes on the original wages because as the investment grows, the tax liability grows proportionally.
  4. There is no guarantee that the tax rate at withdrawal will be lower, and a higher tax rate would create a loss

Conclusion:

Many advisors and trusted financial resources understand the rules and procedures of the RRSP but fail to quantify the true and objective costs and benefits of contribution. Before making a contribution, Canadians should consider the net benefit of of all the factors at play, quantify them against other investment opportunities and finally make a truly educated decision.

 

Source: This post is a summary of Chris Reed’s 2015 Paper titled “Rethinking the RRSP’s Benefits” posted on the Social Science Research Network’s website. Chris maintains a financial literacy and investing website at http://www.retailinvestor.org

 

Posted in Bank Accounts, Financial Education, Income, Investing, Money Saving Tips, Risk Managenent, Tax

How Mortgage Lenders Treat New Build Homes

floor-planI have had a lot of questions from realtors and their clients regarding the way mortgage lenders treat purchasers of new build homes in Ontario. There are some key points that are different for new builds than existing ones that I would like to point out. I’ll structure the discussion chronologically.

Pre-approval

Typically, your builder will ask that you bring in a pre-approval when signing the purchase and sale agreement for a new build. This is different than buying an existing home because new builds often close months and sometimes years down the line which usually extends past the validity period of a typical pre-approval. For my clients, I have written letters of pre-approval from our brokerage and had them accepted. However, I have run into the odd time where a builder requires a pre-approval from their on-site mortgage lender. You’re never locked into anything with a pre-approval, so it is not an issue to get one from their exclusive lender and then find the best mortgage for you a month before your closing.

Borrowing for the deposits

You will not find that a mortgage lender will lend you money for the deposits on a new home or an existing one for that matter. Lenders are only able to offer mortgages using real property as security. If you don’t have the title yet, you can’t get a mortgage. That being said, it is very popular for folks to use a line of credit or a similar loan to put down some of their deposit money and spend time paying it back before closing.

Buying an assignment

If a builder permits assignments, you may want to buy or sell one as part of your financial plan. Financing assignments is possible but the choices are limited. Some lenders will only finance the original purchase price and some will even require that the assignment must be to a family member or non-arm’s length person. The mortgage broker industry has lenders that will lend on the appraised value, which is why you should have a talk with a broker (me of course!) in a case like this.

Finishes and other add-ons

Many builders leave the door open to buyers to select finishes and add-ons later in the construction phase of the build. If your builder is able to, you should always request that they amend your agreement of purchase and sale to include these finishes, and the mortgage lender will gladly finance them.

Appraisal

Appraisals for new builds usually occur in the final two weeks before closing because that is when the property is complete enough to have an appraisal. Typically, lenders require that the property is 97% complete for it to be appraised and of course 100% complete for the loan to be advanced.

Builder’s development fees and adjustment costs

Many people are surprised by the fact that mortgage lenders typically do not finance any of the final adjustment costs. The rule of thumb is: if it is not a component of the purchase price, it will not be financed. This is important because some contracts can allow for tens of thousands in final adjustments that need to come out of your pocket to close the deal. Make sure you and your lawyer have discussed the total amount of funds required to close the deal.

 

Below: Weteachfinance fan Liran Nirenberg showing off his best 3 point stance on a 16/12 roof pitch while framing a new home  in Caledon.

liran-building

Posted in Borrowing, Leverage, Mortgages

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