Mortgage refinancing in Canada is the latest domino to topple in the wake of the COVID-19 pandemic’s impact on our economy.
In fact, all forms of mortgage financing have been increasingly more challenging in the past several weeks. Fortunately, most purchase transactions already committed to during these early transition stages are still going through.
Refinances are another matter though. They are uninsurable, so the lending risk sits squarely with the lenders; whereas purchase transactions facilitate changes of ownership, and the associated mortgages are a necessary and essential part of that process. Mortgage refinances are arguably a non-essential process.
When people refinance their mortgage, it is quite simple to get to a better place financially. For some, it is to reduce the mortgage interest rate, lower the monthly payment, and extend the term. For others, it is to extract equity from the home, often for one of the following reasons:
- consolidating high-cost consumer debt
- combining a second and first mortgage together
- financing home renovation projects
- funding post-secondary education
- assisting with a down payment for children buying their first home
- paying off a consumer proposal early
- funds to pay CRA tax arrears
- tapping into home equity to help children with the down payment or closing costs on their first home
Market uncertainties have rendered most of these more difficult than a month ago, and in some cases impossible.
Three Reasons Why Mortgage Refinances Are Tougher For Canadians
The other day one major chartered bank announced:
“In view of the ongoing COVID-19 situation, the following changes are being made to lending policies affecting new applications submitted to us on or after Thursday, April 9, 2020. These changes are required due to declining employment, energy sector impacts, unstable property values, and restrictions on appraisers being able to access properties for appraisal reports.”
In short, there are three main reasons why mortgage refinances have become much tougher for Canadians with COVID-19.
- More Stringent Scrutiny of Applicants’ Income and Employment
- Lower Appraisal Valuations Than Expected
- Lender Cutbacks in Maximum Loan-to-Value Ratio
1. Tougher Scrutiny on Applicants’ Income and Employment
Lenders are understandably skittish about income stability in the current market. They aren’t just worried about whether you have sufficient income today, but also whether your employment is safe and you will continue to have an income in the months ahead.
Canada lost a record of one million jobs in March 2020 according to BBC News, and you can expect more layoffs and job losses as the full impact of COVID-19 becomes known. The Conference Board of Canada said on April 6th that a combined 2.8 million jobs could be lost during March and April, equal to nearly 15% of total employment.
Even though many of these job losses may prove to be temporary, no one knows.
And if you are in the business of lending money to people, you are going to be looking very carefully at all applicants’ employment income – both for what it is now, and what it might become when the current stay-at-home policy runs well past the month of April, as many experts feel it will.
Prime Minister Trudeau said recently [there will be] “No return to ‘normality’ until a coronavirus vaccine is available.” And that might not be till 2021!
What this means is that even if you had sufficient income to qualify for the desired mortgage amount two months ago, that might not be the case now, and as such, lenders have become more conservative and risk-averse.
Mortgage Lenders Now Want to See All Income Documents Upfront.
If the borrower’s income and employment cannot stand up to scrutiny, there is no point going further. Here is what lenders are saying right now:
One Chartered Bank Says:
For any application using self-employed (BFS) income, in addition to standard income documents, the broker must provide us with a description of the business, when established, a number of employees, and its current status (e.g., operating, shut down).
Note: we may request additional income documents or conduct additional due diligence at our discretion to verify current income/employment status.
Additional due diligence will be required to assess the viability of the business post-COVID-19. To assist in the assessment, please consider asking your client for their most recent financial reporting, i.e., interim tax reporting.
One Monoline Lender Says:
If a borrower has been laid off, we will not use their income to service the file unless an exception is granted by us and the mortgage insurer (if required). Neither EI nor the Government of Canada Emergency Response Benefit is eligible for inclusion in qualifying income.
One Credit Union Says:
As we all work through this challenging time together, we will be reviewing the income sources of all applicants in relation to the Essential Service workplace published by the Ontario Government. https://www.ontario.ca/page/list-essential-workplaces
As you would expect, if your applicants do not work in one of these essential service sectors, we will require additional confirmation of their employer’s commitment to continued pay during the COVID lockdown.
We will not utilize any temporary Canada Emergency Response Benefits in qualifying calculations.
2. Appraisal Valuations Are Coming In Lower Than Expected
Appraisers rely on recent sales data to come up with comparable properties for their appraisal reports. But sales are down so much since mid-March there are fewer to compare to. As reported in the Globe and Mail, Carolyn Ireland on March 31, 2020, wrote:
“Ontario remains under a state of emergency, and while the provincial government deemed most of the real estate industry “essential,” it did so in order to permit transactions to close – not to allow the industry to carry on with business as usual.”
And there is no incentive for appraisers to go high on their estimates – in the teeth of so much pessimism and conservatism. I think we will start to see more and more transactions fall off the rails because of low appraisal values.
Anecdotally, I’m seeing behavioural changes among appraisers that will lead to more values coming in lower than would have been expected a short while ago.
For example, some appraisal values are being submitted with a low, medium and high value. The other day a colleague had a mortgage amount cut back with a major chartered bank. The low was $1.5 million; the medium value was $1.6 million and the high value was $1.7 million. The bank had to take the medium value and the loan was cut back by 130k.
And, Actual Resale Values Are Starting to Drop
Rob McLister over at RateSpy notes, “If HouseSigma is in the ballpark, median GTA home prices are sliding hard in April. It estimates the median GTA home value is down to $740,000. That’s a 6% drop from the February peak of $789,000. Of course, these are just estimates and the data for April is volatile and incomplete.
We’ll check HouseSigma numbers against official real estate board data in early May. Realtor quote of the day:
“A couple of my sellers are nervous that things are going to get worse, so they’re taking what they can get.”
The fact is listings are down dramatically, and there are no open houses anymore. Buying a home for many is a luxury to be deferred until things settle down.
So the net is, it appears appraisers are being more cautious today, and there is nothing on the horizon that’s likely to change this. No one knows how fast buying activity will pick up when the dust settles from COVID-19, so cautious valuations are probably the new normal.
3. Lower Loan-to-Value Ratio Lending Maximums
Before COVID-19, only private mortgage lenders could refinance higher than 80% of the appraised value of a property. It’s against the rules for institutional lenders. Mind you, there are not many brave souls who want to lend over 80% these days.
One small bank has quietly announced they will only refinance to 75% of the appraised value. And many B-lenders, on their own volition, have already cut their maximum loan to value (LTV) to 75%, and that is in densely populated urban areas.
Their maximum LTV is less in rural areas and smaller cities. This percentage will face further downward pressure in the coming months.
And right now, private lenders are also exercising more caution than usual, pulling back on their maximum LTV. The individual retail lender has already gotten cold feet and isn’t at all happy over 50% LTV. Mortgage Investment Corporations (MICs) remain open for business at decent LTVs, but many are expecting higher overall returns on their capital.
These lower loan-to-value ratios, coupled with declining appraisal values, are shrinking the number of fundable mortgage refinance transactions.
Is There a Bright Spot for Refinances?
There’s an old adage that lenders like to give loans to people that don’t need it. That is probably more true today than ever, including for refinances.
In the United States, mortgage rates have already begun to fall quickly, especially for terms of 10 and 15 years, and there is rising interest among many to take advantage of a once-in-a-lifetime opportunity to refinance for a lower rate and radically reduce the remaining term of their mortgage. If you have sufficient equity that a light valuation doesn’t matter, and secure income, this could be a really great time to refinance.
This hasn’t happened yet in Canada but could be the next phase for us as well. And, in general, if you have good enough income, have lived in your home for a while, and haven’t borrowed against your growth in equity, you may still be a good candidate for refinancing. (I’ll write more about this in a future article).
It’s a completely different world for mortgage refinancing than just a month ago.
Factoring together loss of income, lower real estate values, tougher appraisals, and lower loan-to-value ratios, it’s not hard to understand why the landscape for mortgage refinances has cooled considerably. Some refinances for specific types of borrowers will still be possible, but most of the typical cash-out deals we’ve seen for the last several years using home equity to solve debt problems, or large cash needs, are going to be fewer, and much harder to do.
The final word on this topic comes from respected industry veteran Ron Butler, who says, “Nothing will be the same for maybe the next two years. The old world of lending is gone.”