One of the most rewarding investments is the purchase of a principal residence.
Getting away from paying rent and building equity can be a significant financial step in the right direction. Many younger people today may not know the numbers regarding what it would take for them to make such a significant purchase. My recommendation would be to begin by setting goals and gaining knowledge.
This article should not replace meeting with a financial institution and getting specific advice from a mortgage specialist. As a starting point, I want to illustrate some numbers using the average selling price of a single-family home in Victoria, which was $846,500.00 at the end of September 2019, according to the Victoria Real Estate Board. Also, for illustration purposes, we can use the average selling price of a condo being $511,600.00 in Victoria at the same point in time.
What are the key ratios that you look at?
The four key ratios for mortgages are: Total Debt Service Ratio (TDSR), Gross Debt Service Ratio (GDSR), Loan To Value ratio (LTV), and Pressure Test Interest rate (PTI).
To calculate your Total Debt Service Ratio, take your total debt and divide it by your income. Total debt for this ratio includes the new mortgage, heat, property tax, condo fees, car loans, etc. Your income is the amount that is represented on your tax return or T4 slips. Once all of these numbers have been verified, the ratio cannot exceed 44 per cent. For example, if your gross monthly income is $6,000 per month, then the total overall debt cannot exceed $2,640 per month.
Gross Debt Service Ratio is similar to the TDSR. The main difference is that the GDSR only takes into account mortgage-related debt. Mortgage-related debt would include mortgage payment, heat, property taxes and condo fees (if applicable). Once you have this information, you apply the same formula of taking your mortgage debt and dividing it by your income. Typically, the ratio for GDSR cannot exceed 39 per cent. Using the same numbers as above, if your gross monthly income is $6,000 per month, then the total mortgage-related debt cannot exceed $2,340 per month.
The Loan To Value Ratio is another key ratio used by mortgage lenders. When mortgage lenders look at this ratio they are first looking to determine if the mortgage is a high ratio mortgage or a regular mortgage. A high ratio mortgage is one where you are financing more than 80 per cent of the value of the home. When you have a LTV of more than 80 per cent, you then are required to get mortgage insurance. A regular mortgage is when the LTV is lower than 80 per cent and there is no requirement to obtain mortgage insurance.
The Pressure Test Rate is essentially a stress test to see if you could handle higher mortgage payments if interest rates were to rise. Currently, the rate used in Canada is 5.19 per cent which can be changed by the federal government. This rate decreased in July 2019 for the first time in three years. For any person applying for a mortgage for a new purchase, refinancing an existing mortgage, or purchasing an investment property, they are required to have the PTI test applied.
Determining a down payment amount on a property is not black and white.
The down payment amount can fluctuate because the mortgage amount can fluctuate based on your income and ability to handle the ratios mentioned above. The down payment can be as low as five per cent with the assumption that the applicant's income is able to support the other 95 per cent. For any down payment that is less than 20 per cent, you must factor in the high ratio insurance premium. For any down payment which is 20 per cent and above, then there is no high ratio insurance involved, and you would have a better chance at getting a higher approved mortgage amount.
Using the average selling prices for a home and condo in Victoria, mentioned above, let’s look at both regular and high ratio mortgages with respect to the required down payments. This provides four different down payment scenarios as follows: house with a high ratio mortgage; house with a regular mortgage; condo with high ratio mortgage; and condo with regular mortgage. The high ratio mortgages will require mortgage insurance and we assumed a 20 per cent down payment on the regular mortgages.
House price $846,500
Scenario 1: House High Ratio Mortgage
- $500,000*5 per cent = $25,000
- $346,500*10 per cent = $34,650
- Total down payment = $59,650
(Note: CMHC-insured mortgage loans require five per cent down payment on the purchase price portion up to and including $500,000 and ten per cent down payment for the purchase price portion between $500,000 and $1,000,000).
Scenario 2: House Regular Mortgage
- $846,500*20 per cent = $169,300 (Minimum down payment to avoid mortgage insurance).
Condo price $511,600
Scenario 3: Condo High Ratio Mortgage
- $500,000*5 per cent = $25,000
- $11,600*10 per cent = $1,160
- Total down payment $26,160
Scenario 4: Condo Regular Mortgage
- $511,600*20 per cent = $102,320 (Minimum down payment to avoid mortgage insurance).
Understanding how mortgage insurance works
There are three companies in Canada that provide insurance for high ratio mortgages: Canadian Mortgage and Housing Corporation (CMHC), Genworth and Canada Guarantee (CG). All three of these companies can do high ratio mortgages and can provide more options for banks and customers. As an example, sometimes the CMHC might not approve a deal so the banks may need other options in order to have the mortgage insured and approved. For insurance premiums, it's based on the per cent of adown payment up to 20 per cent.
To illustrate this, we will use CMHC insurance. Below we have included a table from the CMHC website for the premiums. Most questions can be looked up on the CMHC's website.
|
Loan-to-Value |
Premium on Total Loan |
Premium on Increase to Loan Amount for Portability |
|
Up to and including 65% |
0.60% |
0.60% |
|
Up to and including 75% |
1.70% |
5.90% |
|
Up to and including 80% |
2.40% |
6.05% |
|
Up to and including 85% |
2.80% |
6.20% |
|
Up to and including 90% |
3.10% |
6.25% |
|
Up to and including 95% |
4.00% |
6.30% |
|
90.01% to 95% - Non-Traditional Down Payment |
4.50% |
6.60% |
Using Scenario 1 for a house above, let’s walk through the math. If the house purchase price is $846,500 and your down payment is $59,650 then the mortgage amount is the difference, or $786,850. Therefore, using the table above the mortgage insurance premium is $31,474. This is calculated by multiplying $786,850 x four per cent. The mortgage amount that would need to be approved would be $818,324. This is calculated by adding the original difference of $786,850 plus the mortgage insurance premium of $31,474 = $818,324.
Using Scenario 3 for a condo, let’s walk through the math. If the condo purchase price is $511,600 and your down payment is $26,160, then the mortgage amount is the difference, or $485,440. Therefore, using the table above the mortgage insurance premium is $19,417.60. This is calculated by multiplying $485,440 x four per cent. The mortgage amount that would need to be approved would be $8,324. This is calculated by adding the original difference of $485,440 plus the mortgage insurance premium of $19,417.60 = $504,857.60.
What would your monthly payments be?
For illustration purposes, let’s assume you are going with a five-year fixed interest rate of 2.89 per cent, a 25 year amortization, and a monthly payment schedule.
Let’s go back to the previous four scenarios:
House price $846,500
Scenario 1: House High Ratio Mortgage
- Purchase price: $846,500
- Down payment: $59,650
- Insurance premium: $31,474
- Mortgage amount: $818,324
- Payment per month: $3,826.64
- House price $846,500
Scenario 2: House Regular Mortgage
- Purchase price: $846,500
- Down payment: $169,300
- Mortgage amount:$677,200
- Payment per month: $3,166.72
Condo price $511,600
Scenario 3: Condo High Ratio Mortgage
- Purchase price: $511,600
- Down payment: $26,160
- Insurance premium: $19,417.60
- Mortgage amount:$504,857.60
- Payment per month: $2,360.81
Condo price $846,500
Scenario 4: Regular Mortgage
- Purchase price: $511,600
- Down payment: $102,320
- Mortgage amount:$409,280
- Payment per month: $1,913.87
The above monthly mortgage payment numbers were taken from the CMHC online calculator. You can change any of these numbers to fit your specific scenario. To purchase a house with a 20 per cent down payment and avoid mortgage insurance, your approximate family income would have to be $115,000 (assuming you have no other debts). To purchase a condo with a 20 per cent down payment and avoid mortgage insurance, your approximate family income would have to be $75,000 (assuming you have no other debts). These numbers are only approximate numbers to be used as a general guideline to help you begin the process of planning the largest financial decision you may make in your life.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com
