The politicians say to the banks "lend money". The banks say "we are lending money". And yet the credit freeze is still frozen.
Well, the truth is banks are lending, but not in a way most people think, and the way they are lending now will not stop the downward trend of the economy. If anything it might exasperate it more to the down side.
The fact is, the banks have changed the rules on how they lend money and provide credit from just 6 months ago, which has nothing to do with one's own credit rating.
I'll give you an example of what and how the banks in Canada were doing business then as opposed to now, and you will see that lending money is not what it used to be.
Remember when home prices shot up 2-3 years ago and the economy was booming? Well if you were lucky enough to own a house before the boom, you were now in a position to tap in to the equity that your house had accumulated. Banks, as well as private lenders made perfectly sure that you knew as a home owner that you could draw a line of credit or a second mortgage on your house without re-mortgaging the whole house.
We purchased our home in March 2006 for $299,000.00. 15 months later I knew our house was worth about $625,000.00. I went to our bank the CIBC to get a line of credit against our house. We still had the original mortgage of about $288,000 with another lending institution. The CIBC appraised our house at $640,000 in June 2007 and gave us a line of credit of $200,000. When the Canadian banks were okaying loans of any sort, it being Lines of Credit, Personal loans, Mortgages, they have a system that they use to determine if the borrower can handle and or qualify for a specific amount of debt on a monthly basis. The borrower's debt can not exceed 40 or 42% of their gross income. Example, we (my wife and I) in 2007 earned $100.000/yr total before taxes and all other deductions. In the bank's eyes we qualify for $40,000 to $42,000/yr in debt payments. So if you take $100,000 that we earn on a yearly basses and divide by 12 months, our gross pay per month = $8,333.33. Now take $8,333.33 and divide it by 42% and that = $3,500.00 per month that the banks will allow us to owe in monthly payments towards all outstanding debt. So with our existing monthly mortgage payment of $2,172.79 which includes our property tax we would be allowed to incur additional monthly debt payments of up to $1,327.21. Now here is where it becomes interesting. In June 2007, and for as far back as I can remember, up until September 2008, when the banks calculated the monthly payment of a Line of Credit , they (the banks) only calculated the actual interest accrued monthly on that line of credit. So for example if we spent all that credit and owed the full $200,000 of that line of credit in 2007, with the then interest rate of 5.50%, that worked out to $916.66 in our minimum monthly interest payment without paying down the principal, and remember in the bank's eyes that's all we had to pay monthly. If the interest rate went up, our minimum monthly payment went up, if the interest rates went down our minimum monthly payment went down. So according to the bank, and this was with all the banks at that time in Canada up untill September 2008, our mortgage payment of $2,172.79 plus the minimum interest payment on our Line of Credit of $916.66 gave us a total of $3,089.46 in monthly debt, which was within the guide lines of the 42% monthly debt to gross income ratio.
Now this is very important, and you will need to remember this for later. In 2007 as per the banks, a $916.66/monthly payment times 12 months = $11,000.00/yr in debt payment for just the line of credit. At $11,000.00 in debt payment, that would eat up $26,000.00 of our gross income to qualify for this line of credit, leaving us with $74,000.00 in gross income for our mortgage and any other debt that we may incur. In other words as per the banking system in Canada up until September 2008, to have this line of credit at an interest rate of 5.50% we need to earn $26,000 in gross income per year just to qualify for this one loan (the line of credit).
Now that all sounds reasonable.
In early February 2009 I phoned CIBC to find out if we can transfer our mortgage over to them and get a better rate to boot. I gave CIBC actual and factual numbers of our income and debt over the phone and asked if this will work? "I don't see why not" the CIBC personal banker stated over the phone. I was apprehensive with her answer because of the amount of debt we had accumulated, and I wasn't sure if we would fit in with their module of acceptance of 42% monthly debt to gross income ratio. As much as I wanted our mortgage transfered over to CIBC and at a lower rate, I was not sure if she could swing it. Here's why. As of 2009 my wife and I earn $98,000.00/year, down from $100,000.00 in June 2007, not a big deal. But we accumulated a lot more debt over the past 2 years since we got the line of credit. First our mortgage monthly payment went up from $2,172.79 to $2,207.96 because of a property tax increased, no big deal. Second we maxed out our line of credit of $200,000.00, but the minimum monthly payment has gone down to $500.00 from $916.66, a saving of ($416.66/month). Third we have accumulated additional debt of $91,000.00, for various things like a vacation, car purchase, credit cards and investments. So as per the Canadian banks module that I knew as of June 2007 (which I had no reason to think had changed), I had figured if we consolidated all of our additional debt of $91,000.00 in to a personal loan we might be able to make it work, and as I already stated above so did our personal banker.
Here is how I though it could work (with what I knew).
First the mortgage. If the CIBC would take over the mortgage from the lending institution that currently holds it, they (the CIBC) would give us $4000.00 cash back and we can lock in our interest rate for 5 years at 4.39%, a far cry from the 7.25% which we are now paying. That would bring our monthly mortgage payment with property tax, down to $1663.62 from $2,209.96 a savings of ($546.34/month). Second, if we took that $4,000.00 cash back that the CIBC gave us for transferring over the mortgage, and put that against the $91,000 of our additional debt that would bring it down to $87,000 then consolidate that $87,000.00 in to a personal loan at 5.75% over 5 years (which is that maximum length of a personal loan that they will do), that would give us a monthly payment of $1,696.00. Third, remember the line of credit of $200,000.00, it is now at a 3.00% interest rate, with a minimum monthly payment of $500.00 from $916.66, a saving of ($416.66/month).So with our monthly mortgage payment with property tax of $1663.62 + our consolidation loan monthly payment of $1,696.00 and our line of credit minimum monthly payment of $500.00, our total debt monthly payment is $3,859.62 divide by our gross monthly income of $8,166.67 (remember that we earn $2,000 less per year then in 2007) which works out to 47.3% monthly debt to gross income ratio.I thought not bad, maybe they will squeeze it through? Remember I wasn't so sure, but our personal banker thought it was possible.
Now before I go on, I just want to be clear about why I thought that we could get a consolidation loan for our outstanding debt of $87,000.00 at 5.75% over 5 years. Three days before our appointment with our CIBC personal banker, I checked with someone I knew at another CIBC location to find out what the interest rates were on personal loans. I knew they would be higher then any mortgage or line of credit interest rate. He said "that would depend on your credit score" and he proceeded to show me right off his computer screen what the rates were. They ranged from 5.75% to 9.75% for a personal consolidation loan. I thought no problem, our credit ratting is perfect, we have not missed a payment of any kind in over the last 15 years. So there was no reason for me to think that we would not get the 5.75% interest rate on our personal loan.
Now here is what the banks are doing as of September 2008.
First, remember how the banks calculated the minimum monthly payment on a line of credit, which was interest only? Well nothing has changed as far as how they bill us or anyone else for that matter. We get our statement in the mail and there it is, an interest only minimum monthly payment on our $200,000.00 line of credit at 3.00% interest rate which works out to about $500.00/month. If I want to pay more which I'm sure most people do to some degree than just the minimum, we can. But when we went to the CIBC for our scheduled appointment, we got whipsawed. Our personal banker took all our information and guess what, no go! Here's why. According to our personal banker, when calculating the minimum monthly debt to gross income ratio, she put down $2,000.00 as a minimum monthly payment on our line of credit of $200,000.00. That's right, 1% of the total debt of the line of credit for our minimum monthly payment which works out to $2,000.00, not $500.00. I of course said "but I have the statement that CIBC sent us in the mail right here showing the minimum monthly payment of $500.00", she said, "doesn't matter I can't change it if I wanted to". She also said that "all the banks are doing this now since the credit freeze last September 2008". So, when I was doing my calculations at home before going to CIBC, I calculated that our line of credit minimum monthly payment of $500.00 x 12 months = $6,000.00/year in debt payment for just the line of credit. At $6,000.00 in debt payment, as per the debt ratio of 42% that would require $14,300.00 of our gross income to qualify for just this line of credit, leaving us with $83,700.00 in gross income for our mortgage and any other debt that we may have accumulated. Remember in 2007, the interest rates was 5.50% on our line of credit, with a $916.66/monthly payment x 12 months = $11,000.00/yr in debt payment for just the line of credit. At $11,000.00 in debt payment, that required $26,000.00 of our gross income at that time to qualify for this line of credit, leaving us with $74,000.00 in gross income for our mortgage and any other debt that we may accumulate. So of course I thought that our monthly debt to gross income ratio on our line of credit had improved, because of the fact, that the interest rate came down from 5.50% to 3.00%, which brought down our minimum monthly payment, which in turn brought down the monthly debt to gross income ratio on that line of credit from $26,000.00 per year to $14,300.00 per year for qualification purposes.
Guess what happens now with a fictitious $2,000.00 minimum monthly payment on that line of credit on debt to gross income ratio? Well, $2,000.00 x 12 months = $24,000.00/year at 42% of gross income to debt ratio, that requires $57,200.00 of our $98,000.00 gross income, just on a qualifying basis for only our line of credit. That would leave us just $40,800.00 of our remaining gross income, to cover our mortgage and other debts for qualification purposes of income to debt ratio for the year. So, when the $40,800.00 of are remaining yearly gross income is divided by 12 months = $3,400.00 in monthly gross income and divide that by 42% monthly debt to gross income ratio, that would leave us with just $1,428.00 per month to cover our mortgage and other debts. $1,428.00 per month doesn't even cover our currant mortgage payment let alone any of our other debt for qualification purposes only. But remember, that 1% $2,000.00 minimum monthly payment on our line of credit is fictitious.
Now here is what that really means to us and anybody else in Canada who has an existing line of credit. The difference of what CIBC bills us, and how they qualified us for this line of credit, back in 2007, with a now 3.00% interest rate, which works out to $500.00/month x 12 months = $6,000.00/year in payments, required a gross income of $14,300.00/year for qualification purposes as per the 42% debt to gross income ratio. But now with a 1% fictitious $2,000.00 minimum monthly payment on that same line of credit x 12 months = $24,000.00/year (remember this not what they bill us or any body else), we need $57,200.00/year in gross income as per the 42% debt to gross income ratio for this one loan for qualification purposes only. That's a difference of $42,900.00/year in gross income that we have to come up with just to qualify for our present line of credit, and again for qualification purposes only. To have just this current line of credit loan, we have to be earning $42,900.00/year more in gross income.
I don't know about you, but I don't see our yearly gross income going up from $98,000.00/yr to $140,900.00/yr just to qualify for the line of credit that we already have, (not in this economic environment)?
Now, I am sure some people will say that we screwed ourselves by spending more then we earned and going deeper into debt. After all just because we were given a line of credit of $200,000.00 didn't mean that we had to spend it all, and more. No, thats right we didn't. And I'm not whining about our debt situation. We spent freely and willingly. We purchased a car, went on vacation, spent a lot on our house, and we invested most of it. Not getting what we wanted from the bank is frustrating and in the end it will cost us a lot more in interest the way things are, but we will survive (providing we keep our jobs).
The point is, think about all those home owners across Canada, and maybe in the US as well who's homes went up in value over the last 4-5 years and got lines of credit?
Well if Bob in Calgary Alberta got a line of credit of $100,000.00 2 years ago and still has it. At todays interest rates of 3.00% his minimum monthly payment is only about $275.00. But what if Bob needs to get a loan from the bank, any loan even when applying for a credit card, his line of credit minimum monthly payment of about $275.00 is seen as a fictitious 1% minimum monthly payment, which works out to $1,000.00. Which in turn requires Bob's income to rise from say $60,000.00 to $81,000.00. Because Bob has that line of credit, he has to earn $21,000.00 more per year just to cover the (fictitious $1,000.00 minimum monthly payment on his line of credit). And this has nothing to do with his credit score.
If Stacy in Regina Saskatchewan got a line of credit of $250,000.00 against her house only a year ago and still has it. At todays interest rates of 3.00% her minimum monthly payment is only about $687.50. But Stacy needs a new car or a used car, and maybe the $250,000.00 she got from the bank a year ago went to start up a business, so it's tapped out, the money is invested and she's making her payments on time (remember this has nothing to do with her credit score). She tries to get a loan from the bank, remember any loan even when applying for a credit card. Stacy's actual minimum monthly payment on her line of credit is only about $687.50, but the bank sees her line of credit as a fictitious 1% minimum monthly phantom payment, which works out to $2,500.00, which in turn requires Stacy's income to rise from say $75,000.00/yr to $126,000.00/yr just because she has that line of credit. Stacy has to earn $51,000.00 more per year to cover the (fictitious $2,500.00 minimum monthly payment on his line of credit). And again this has nothing to do with her credit score.
So, what do you think a bank would do if a customer applied for a loan of any kind with them, and they proceeded to tell the bank that they earn $80,000.00/yr, but when the customer had to bring in their last 2 pay slips so the bank can verify that figure, and the bank looks at those pay slips, and the customer only earns $72,000.00/yr according to those pay slips, would it not be suprising if the bank did not use the word "Fraudulent"?
So how is it possible for banks to be giving out loans of any kind with this new fictitious 1% minimum monthly payment on lines of credit against the monthly debt to gross income ratio?
2 ways.
1. Don't have an existing line of credit for the bank to use their new fictitious 1% minimum monthly payment debt to gross income ratio.
2. If you have (still) enough equity in your home to re-mortgage your existing mortgage with your line of credit? Then the bank will absorb that line of credit into your mortgage and no more line of credit, no more fictitious 1% monthly payment debt to gross income ratio.
Mmmm, how nice for the banks. Most everybody knows how debt pay down works with lines of credit, credit cards, personal loans, any debt that is not a mortgage can be paid down to zero with no penalty.
If home owners are in a bind, have a line of credit and enough equity in their home, they can get that debt absorbed into their mortgage, but now they can never pay if off without a nice fat penalty, because it's a mortgage now.
Oh, by the way, home prices have fallen across the country, from 10-25%. Remember our house? The bank appraised it at $640,000.00 just 20 months ago. Now it worth about $550,000.00.
If you think that fictitious 1% minimum monthly payments are only on lines of credit? There's more.
Remember I wanted to consolidate that $87,000.00 of debt ($91,000.00 before the $4,000.00 cash back for transferring our mortgage) in to a personal loan at 5.75% over 5 years, that would give us a monthly payment of $1,696.00. When our personal banker was entering all of our other debts aside from our mortgage and line of credit debt, she was entering all our individual minimum monthly payments on those debts at a 3% minimum monthly payments, and not the actual minimum monthly payment as per the statements that we receive in the mail. Sound familiar? For example, one of our credit cards has a balance of about $9,920.00 with a minimum monthly payment of $72.00, (it's at 6.75%). Guess what she does? She, our personal banker, enters that minimum monthly payment at 3% which adds up to $297.60/month for that one credit card. As with the line of credit statement that we brought down with us, I too had the credit card statement which I showed her, that $72.00 was the minimum monthly payment on that credit card. She said, "doesn't matter I can't change it if I wanted to", just like before. Apparently this fictitious 3% minimum monthly payment on credit cards against the monthly debt to gross income ratio has always been like this, even before the credit freeze. So again more fictitious minimum monthly payments, but this time on credit cards. And again this has nothing to do with our credit score. A fictitious 3% minimum monthly payment on credit cards will go a long way to insuring that it will be vary difficult for people, even if they don't have a line of credit or a mortgage on a house, to receive any new credit from any bank in
Canada, within the 42% monthly debt to gross income ratio qualification system.
Lets say Robert in Toronto has $65,000.00 in credit card debt, but no other debt, no line of credit, no mortgage, no loan, just credit card debt, Well if Robert wants any additional debt of any kind from any bank, lets see how they will look at that? This should be easy, $65,000.00 x 3% per month = $1,950.00 as a fictitious minimum monthly payment that the bank states to Robert that they have to take in to consideration regardless of what his true minimum monthly payments are. So as the 42% monthly debt to gross income ratio goes, Robert has to be earning about $56,000.00/yr just to stay within that 42% monthly debt to gross income ratio. If Robert wants any more credit of any kind from any bank, he better be earning a lot more then his $56,000.00/yr.
Now unfortunately the fictitious numbers don't stop there with minimum monthly payments. Remember, with all the above examples that I have given so far, all of them have had NOTHING to do with one's own credit rating. The bank, unbeknownst to me, have their own credit rating system that they use before they even incorporate the customers own personal credit rating from the credit bureau.
When we were going over the numbers with our personal banker for the consolidation loan, she came up with a 9.75% interest rate for a monthly payment of $1,862.00. I said "how's that?". "I figured it out at home at 5.75% for a monthly payment of $1,696.00", a difference of ($166.00/month). After all I did assume that we would get the best rate because of our credit rating. I knew our credit rating would be rated quite high because we have not missed a payment of any kind in over the past 15 years. First she said "it's because of the amount of debt which has nothing to do with your personal credit rating", she also said "see this" as she pointed to her computer screen, "that's the rating that the bank gives you as a credit score". "How's that work?" I asked. She said "the more debt you have the lower the score". I asked "regardless of our credit rating?" She said "yes, this is the banks credit rating system on how much debt you have which has nothing to do with your personal credit rating, yet". I was curious, so again I asked "how dose that work?". She explained to me "for example if you have a Visa and the limit is $25,000.00 and your currant balance on that Visa is $20,000.00 your score goes down, because it's close to the limit". So again I asked "if $20,000.00 is my currant balance on Visa card with a $25,000.00 limit , at what point or how low does my balance have to be in relation to my limit to I get a higher credit score from the bank?". She said "your balance would have to be half or less of your current limit on that one credit card for you to get a better credit score from the bank, and that's the same for each and every one of your credit cards". So before the bank even does a personal credit check on us, they have their own fictitious credit score that they are implementing on us which has nothing to do with our credit history. After I got the gist of what was going on, our personal banker said, "lets do your personal credit check, that should bump up your score with what we have given you so far". It did and we did get a better rate, but not the 5.75% that I thought we should get, we got 8.50%, not even half way between the lowest and highest rates that was available. Remember that monthly debt to gross income ratio. Well with the banks own credit rating system that they use to push up the interest rates that they offer, it will in turn bring up the monthly payments which will then affect monthly debt to gross income ratio and will be just one more reason why the bank can't or won't be forking over very many loans in the near future.
So what does this tell you about the willingness of the banks in Canada on giving out loans?
Well, it tells me that if they are?, they are few and far between. It's definitely not business as usual.
And it doesn't seem to matter much at all to the banks about your willingness, ability and most of all your track record on paying your bills.
Bonus Material
I didn't want to get into this part of our experience at the bank with the above information because I didn't want to make it anymore complicated then it already is. Remember when our personal banker was going over the numbers for our consolidation loan, and I stated above she originally came up with a 9.75% interest rate for a monthly payment of $1,862.00? Well that was without the $316.73 in monthly insurance payments for just this one consolidation loan.
What really happened was when she quoted us what our monthly payment on our consolidation loan would be, she stated "$2,178.22/month over 5 years" I of course said "what?". Then she broke it down, $1,862.00 was for the loan, $195.70 was for CIBC Payment Protecter insurance and $121.03 was for life insurance, all per month. So I of course said "we already have life insurance through my wife's work". She looked at me as if I had three eyes, and proceeded to say "well that's a big loan". After a couple of minutes of insisting that we already had insurance, she removed those monthly insurance payments, which by the way, not only would have brought up our monthly debt to gross income ratio from us needing $53,500.00/yr to $62,500.00/yr in gross income for just that one loan, which made it ever more difficult for qualification purposes. But the cost of this $316.73 in monthly insurance payments would end up costing us about $3,800.76/yr x 5 years = $19,003.80 in unwanted, unwarranted additional total payment cost to us for this one loan from the bank. Our personal banker also did this when she gave us the monthly payment on our mortgage as well.
I wonder how many people that have already received mortgages and personal loans through the banks and were convinced that they needed these (non mandatory) monthly insurance premiums attached to their monthly loan payments?
The reason why I am pointing this out is, in the past when we did our last 2 consolidation loans with the same personal banker at the same bank, see were asked, "are your interested in adding some sort of insurance, due to job loss, disability, or death, that would be tacked on to your monthly payment over the course of the loan?". We declined it then as well. But now it is coming across as if, we not only need this, but I was beginning to wonder how willing our personal banker was about (if we qualified) ok'ing the loans without some sort of insurance being attached to it?
I don't know if this is happening anywhere else outside of Canada? But I have a feeling that at some point in time in the future, our Canadian banks will find away to make it mandatory for their customers to have some sort of insurance attached to every loan that they give out . After all, our Canadian banks have been in the insurance business for the last 10 years or so and have been selling this type of insurance to their Visa and Master card holders.
There's nothing like a crisis, especially a credit crisis for the banks to justify and peddle their insurance as a way to protect the customer, and of course themselves, who by the way just happen to be in the business of selling it.
How convenient!
Bonus Material II
We received a letter from Accredited Home Lenders on February 9 2009 stating that "they would not be renewing our mortgage, and that we had to find alternative financing by April 1 2009".
Well, I just phoned Accredited Home Lenders February 26 2009, to inform them that we were unable to transfer the mortgage over to another lending institution. I didn't mention this before because when I first wrote this, I thought if we didn't get the mortgage transfered, they Accredited Home Lenders would just allow us to keep making our monthly payments by renewing our mortgage for another year or so. I didn't realize the severity of our situation until we were unable to transfer our mortgage.
They stated over the phone that "we have until July 1 2009 to transfer our mortgage over to another lending institution or they Accredited Home Lenders will foreclose on us".
That's right, there calling in the loan even though we have not missed or were late on 1 monthly payment over the past 35 months (since we first purchased the house).
Apparently, they Accredited Home Lenders are in a little financial trouble and are not renewing any of the Canadian mortgages. There going down like so many other lending institutions, and they want their money.
If your interested, just Google them, you'll get the gist.
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