At Your Service

There are many things that come to mind when you think about service. Could be the waiter or waitress that served your dinner. Perhaps you went to Service Canada and got something done. Growing up in the country it was even common to hear a farmer say that the bull serviced the heifer. The word can mean many things to many people. But I am most concerned with the word when used behind the word DEBT.

As brokers we all dread someone with a high TDS. Technically it is TDSR, but apparently it was easier to drop the R off the end. The important factor that the lender wants to know is if our client can service the debt load. Servicing something is very important – whether it be your car, your clients, or even your debt load.

Over the last 12 months there are many asset classes that have risen. Interest rates, live cattle futures, Orange juice, oil, the list is endless. However, no one really cares about their TDSR on their morning cup of OJ. Why? Because it isn’t a major consideration in their budget. I could double my OJ consumption, and my OJ service ratio wouldn’t increase all that much.

Debt though – that is another story. Canada is now the most indebted industrialized country in the world. We have a lot of debt. We use a lot of debt, and prior to 2022, we could service that debt. Well, that has changed. Debt service costs have skyrocketed higher, and people are having a problem hanging on. This isn’t really breaking news for any of us. We know this.

We are all eagerly awaiting the reduction in interest rates that should be, could me, might be, maybe around the corner. Sure, great, fantastic – but I don’t think that will really matter. There are 3 main components that go into servicing for mortgages ( GDS ), and I think a lot of people miss the big picture sometimes. So, let’s take an example, and look at a hypothetical:

Client bought a house in early 2022. They bought at the peak, and locked in to a 5 year fixed rate. They got, oh lets say 2.59%. They handle the payments quite easily, and they are fine. They qualified at the 5.25% stress test rate. So far so good. However, the other 2 components of GDS is heat and property taxes. This is where it gets a little tricky.

Heat is probably the largest joke of our business. We have to use a $100.00 a month qualifier, that has been at this level for 3 years or more. In the last 3 years, natural gas has more than doubled, and carbon tax has been added. I would love to meet the family that heats their entire house in a Canadian winter for $100.00 a month. It is laughable. Could we see a more realistic heat component put in? Anything is possible.

Property taxes, I believe are the single largest problem coming down the pipe that no one gives second thought to. So let’s explore. We all know that MPAC did not impose the hikes in 2020, 2021, or 2022 due to COVID. This means that in 2024, MPAC will have to ram through about 8 years of assessed value increases in a span of 4 years. MPAC is always backward looking, so the data they will use for 2024, will be based on 2020 to 2023. I think we would all agree that 2020 to 2023 saw the largest increase on record in house prices. So, the 2020 assessment increase ran from 2015 to 2019, and the 2024 increase will run 2020 to 2023. That means that every property in Ontario is currently assessed at 2015 levels. What has Canadian housing done since 2015? Well, it has basically doubled!!

When MPAC looks to phase in the property price assessment growth over the coming 4 years, they will be basically doubling the value a homeowner pays taxes on. If you are currently paying $3,000.00 a year, that means your property taxes could DOUBLE to $6,000.00 BEFORE we factor in any mill rate growth from municipalities. Cities are looking to increase revenue as fast as they can, and with inflation linked pay raises, cities are strapped for cash. Many municipalities are running a 4% to 6% mill rate growth per year, so when we add that onto a double in assessed value, we get, effectively a 128% growth in property taxes payable. If you doubt the large mill rate increases look at the City of Toronto right now, and that will give you a good look into what the future holds for a lot of municipalities.

So, if your clients was paying $3,000.00 a year before, they could easily be looking at $7000.00 + in property taxes by renewal. Now, of course this is an extreme example, but reality may not be that far off from this for a lot of homeowners.

The issue comes in when we now have to factor that into our TDS for qualification. A $3,000.00 property tax bill for someone who made 60K a year, would be about 5% of their income. Now, of course, GDS is only allowed to be 39% max, so 5% of 39%, means that property taxes ate up 12.8% of the GDS on the application. Let’s assume your clients got some raises over the time of the mortgage, so instead of making 60K a year, they now make 65K a year. However, property taxes are now $7,000.00. Property taxes are 10.76% of the total, or 27.6% of the GDS service amount. Even with a raise, the property taxes are now taking an outsized chunk of the GDS servicing room.

Let’s say that interest rates go down. If you had a $250,000.00 mortgage, and rates went down from their current levels by a full 100 bps. With that 100 bp rate reduction, you would realize about $2500.00 a year in lower payments ( interest only ), but that still would not be enough to make up for the growth in property taxes.

Now, I know a lot of people will give me examples of higher mortgages, lower taxes, etc – and that is fine. I am simply trying to point out that lower interest rates may not be enough to bring relief – or approvals to many of your clients. Property tax increases will make it hard to get GDS down where it needs to be – regardless if interest rates fall. Sure, rates falling will move the GDS in the right direction, but I don’t think it will be enough to balance off the higher property taxes.

Of course, all of this is even before we consider the credit cards, lines of credit, auto loans and student loans that will drive the TDS through the roof. Higher rates, larger payments ,and increased debt amounts will spike TDS rates higher than we have seen in a long time.

Here is hoping that the municipalities that receive a large bump in revenue are able to put it to good use on social housing projects, as they will be needed if you can’t GDS or TDS your client’s application due to higher tax components.