Historical article note: This article was originally published on 2019-10-10. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
Banks are the heart of the economy, pumping funds in and out, and performing the function of credit intermediation. Traditional banking services include payments, deposits, remittances, and loans. As ordinary consumers, the functions we use daily are mostly payments, remittances, and deposits, while loans are not frequently used. Chinese people use credit cards more for payment functions and rarely use the borrowing function of credit cards. However, among all banking services, only loans can help ordinary people achieve leaps in household wealth and accelerate wealth accumulation. Bank loans serve as virtual capital for households, and for those living in capitalist countries, without capital, they can only sell their time to capital—that is, work for others; with capital, even if it is virtual capital, it gives a person the opportunity to become the dominant class in society, that is, those whom workers support.
If you want to make the bank your friend and gain virtual capital to achieve a leap in family wealth, you must first understand the bank, secondly maintain respect, and most importantly, make good use of various loan tools.
01 The Bank's Dad and Mom
If you want to treat a bank as a friend, you need to understand the bank. From the perspective of mortgage lending, the bank's father is OSFI, that is, the bank regulator and the author of mortgage policy B20, which sets the policy requiring a down payment of more than 20% for mortgages; the bank's mother is CMHC, which can both guarantee borrowers with a down payment of less than 20% and buy mortgages from banks, converting them into cash for the banks, similar to the function of the two government-sponsored enterprises in the United States.
B20 is something everyone is very familiar with; it is the stress test policy. According to the stress test requirements, when the borrower’s down payment is no less than 20%, the bank needs to use a minimum interest rate of 5.19% to calculate the borrower’s debt repayment ability, even if the borrower’s actual interest rate is less than 3%. The bank’s overseer, OSFI, is the regulatory agency that strictly regulates banks’ mortgage operations.
CMHC, on the other hand, used both reward and punishment. For borrowers with less than 20% down payment, CMHC provided the guarantee; commercial banks could sell completed loans to CMHC at any time in exchange for cash and continue issuing loans. After the financial crisis, three rounds of QE in the U.S. poured money into Wall Street's capital markets, which is why the stock market has been thriving ever since; 4 trillion yuan in China was given to state-owned enterprises, and private business owners sold their factories to buy houses. How did Canada get through the financial crisis? Canada's market rescue funds were directly funneled to commercial banks through CMHC. After receiving these funds, commercial banks issued more mortgages. Starting at the end of 2008, the Insured Mortgage Purchase Program encouraged banks to sell mortgages to CMHC, which is Canada's version of quantitative easing (QE), but the money was invested in real estate rather than the stock market. Many people do not understand why Canadian real estate surged from 2009 all the way to 2017; media and politicians even misled the public to condemn non-residents. The real reason is: CMHC, a government-managed enterprise, lent money to commercial banks for more loans, boosting transaction volume—cash went to home sellers, solidifying the wealth status of homeowners, and loans went to buyers, giving those without homes a chance to increase their wealth. People who did not buy a house between 2009 and 2017 because they did not understand banks and the Canadian real estate finance system, and instead invested in Canadian stocks, missed a golden opportunity for family wealth growth. Looking back now, many are filled with regret. Those who do not understand banks, the Canadian mortgage financial system, and do not make connections with banks, will continue to regret it.
Starting from November 2016, CMHC stopped purchasing investment property mortgages and only purchases mortgages for owner-occupied homes, which immediately tightened market funds. This news was not reported in the Chinese community, indicating that the editors in the Chinese community simply do not understand useful and professional mainstream media news. The Chinese community still has very little understanding of Canada's mortgage financial system and banks; without leveraging policy trends, it is difficult to find investment opportunities. It's not too late to take remedial action. Learning about and understanding current mortgage policies can help everyone start building a healthy and long-term real estate investment portfolio from now on.
02 The Wudang and Shaolin factions in the Bank of Canada's mortgage policy
In a low-interest-rate environment, bank financial advisors cannot help clients make big profits from small amounts of money; achieving capital preservation and beating inflation is considered a success. In a low-interest-rate era, the investment strategy focuses on building a mortgage-backed asset portfolio because saving money is unreasonable; only borrowing money to buy assets aligns with the trend.
Regarding the policies for approving investment property mortgages, banks are divided into two schools: Wudang and Shaolin. The Wudang school looks at whether the investment property has cash flow, that is, reviewing residential property mortgage loans according to commercial loan approval principles. According to the Wudang school, mortgage ratios in the Greater Toronto Area are generally below 65% of the property value, so leverage on investment properties is low, but even if the owner-occupied mortgage is larger, one can still get loans for investment properties. The Shaolin school, on the other hand, considers the borrower’s total income and debts and does not strictly require each investment property to have cash flow. Therefore, households with low overall debt, such as those who have already paid off their owner-occupied homes, can borrow up to 80% of the property value for each investment property.
The differing approaches of banks provide borrowers with more options. In short, as a borrower, one should cultivate relationships with various banks and understand their policies. Without loan support, real estate investment cannot be undertaken. Those who understand real estate investment are precisely those who know and utilize bank policies most skillfully — nothing more.
Common policies across banks for investment property mortgages include that a borrower cannot have more than 10 investment properties in total, and the number of loans at any single bank cannot exceed 5. If there are more than 10 investment properties, the loan applicant will be classified as a 'real estate operator' and approved according to commercial loan procedures and interest rates. Specific mortgage policies for investment properties vary from bank to bank, with the main difference being how rental income from investment properties is calculated.
03 Different Views on Rental Income
Although the bank's 'Daddy' sets the B20 standard very strictly, there is one aspect that is not specifically regulated and is left to the commercial banks to decide: how to calculate rental income. When calculating debt servicing ability (TDSR), the way in which debts from investment properties and their rental income are calculated determines the level of debt servicing ability, that is, whether it meets the requirement of TDSR being less than 44%. There are two completely different methods for calculating investment property debt and rental income: Method A: Investment property debt is counted as 100%, and rental income is counted as 50% to 80%; Method B: Since investment property debt is offset by rental income, it is not counted as debt, and the monthly debt amount is fully offset against 85% to 90% of rental income. If the result is negative, it is deducted from household income; if positive, it is added to household income. Different banks use different methods, and even the same bank uses different formulas for different types of investment properties. For example, Bank A stipulates that if the property for which a loan is being applied is an investment property, Method A is used, whereas Method B is used when calculating the debt of an applicant's existing investment property. Banks A, B, C, D, and E use different combinations, resulting in as many as 25 calculation methods, which can be very confusing for borrowers.
Different banks also have different ways of determining rental income. The 80% rental mentioned above is because the bank assumes a 20% vacancy rate. Different banks have their own views on the vacancy rate, and there is no uniform regulation. Some banks must see the tax return rental income document T776, some banks accept the lease agreement as the document to determine rental income, and some banks only accept the fair market rental value provided by an appraiser.
These uncertainties and disagreements are giving real estate investors a headache. But they also illustrate one point, which is repeatedly emphasized by Reservoir Forum moderator Ou Shen in the book 'How the Middle Class Protects Its Wealth': spend 80% of your time finding a mortgage, and 20% of your time finding a house.
04 Only by maintaining respect for the bank can you keep the bank as a friend
The bank requires applicants' debt repayment ability to be such that monthly debt is less than 44% of monthly income; otherwise, the loan will not be approved. Therefore, to make friends with the bank, you first need to be a big taxpayer; having too low taxable income won't work.
In order to meet the debt repayment capacity requirement, excessive consumer debt can result in a monthly debt ratio exceeding 44%. Therefore, consumer debt, such as mortgages for owner-occupied homes, car loans, and student loans, cannot be too large. When negotiating investment property loans with banks, it is necessary to postpone gratification and reduce bad consumer debt.
Banks only lend to clients with good credit, so the credit record must be good. Good means repaying borrowed money on time and having no negative records. Only those who are honest in borrowing and lending can make friends with banks.
The collateral for a mortgage is the property, so the property must meet the bank's requirements. If the living area is too small, the bank does not like it. If the house has illegal alterations, the bank will not lend money. If the house has illegal uses, for example, a marijuana house or a rooming house, the bank will not lend money. Only residential properties can apply for a mortgage loan; if the house has commercial uses, for example, a shop on the ground floor and a residence above, mortgage loans cannot be applied for.
05 Make good use of the bank's debt management tools
From the above banking preferences, taking out a loan to buy an investment property is a practice in reducing consumer bad debt and increasing taxable income. If practiced until the mortgage on your own home is fully paid off, and all loans are on investment properties, with tenants shouldering the debt, you can ultimately achieve the positive outcome of using rental passive income to replace salary-based active income. Income depends on the borrower's own efforts, while debt management requires the use of banking tools. The two main tools in the bank debt management toolbox are:
Refinance: This is the most powerful debt restructuring tool. For an owner-occupied home, refinancing can extend the repayment term back to 30 years, reducing monthly payments and increasing borrowing capacity for investment properties. For investment properties, refinancing can allow cash withdrawal to use as a down payment for the next investment property, achieving zero down payment for the next property. During the refinancing process, it is also possible to remove existing borrowers or add new borrowers. Refinancing can add a new line of credit or remove an existing line of credit. In short, refinancing is an opportunity to start over, correct past mistakes, and extract dormant or stagnant wealth in the form of capital, thus accelerating cash flow.
Credit limit/HELOC: A revolving mortgage product that allows you to continuously use the principal you have repaid, just like a credit card. It is also a tool to increase cash flow speed.
06 Those who cannot use bank leverage
People who cannot use bank leverage mainly have two characteristics: 1. low income and little reported tax; 2. damaging bank collateral.
Over the past 10 years, the banks' regulators have continuously demanded that banks tighten mortgage policies, and the banks have voluntarily changed some lending policies. For example, in the past, small business owners, companies established within 3 years, and individuals with low income could make a 35% down payment and obtain a mortgage through the Stated Income program. Currently, this program has been canceled by all banks because the so-called stated income is essentially future income or false income, which cannot be verified. Previously, the loan policies for new immigrants and non-residents were too lenient. Now, banks have resolutely stopped offering opportunities for purchasing investment properties using overseas income; they can only buy owner-occupied homes, and the verification of overseas income has become increasingly strict and rigorous, essentially eliminating the possibility of using new immigrant policies to invest in real estate. The new immigrant policies only apply to owner-occupied home loans. In short, banks are becoming less and less tolerant of unreported income. However, in the past two years, banks have offered preferential terms in loan approvals for high-net-worth clients. High-net-worth applicants can leverage their existing properties or take out loans to buy investment properties.
Illegal renovations and illegal subleasing are actively damaging the bank's collateral—real estate. Banks will not provide additional loans to borrowers who actively cause damage.
Summary: Treat the bank as a friend, and you can use the bank's loans to obtain virtual capital, break through class rigidity, and become part of the propertied class. To make the bank your friend, you must either have a stable income or high net worth assets and maintain a good credit record. Once you have established this friendship, you need to maintain respect and awe, and learn through practice how to use debt management tools. Ultimately, the goal is to eliminate consumer debt and other bad debts, establish an asset portfolio centered on mortgages and real estate, and use passive income to replace active income.