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Getting a Mortgage now – What is a “stress test”?


The Bank of Canada’s recent decision to raise interest rates generated a lot of media attention, because while the increase itself was only one quarter of a percentage point, it was the first move made by the Bank of Canada to increase rates in the past seven years    Speculation was whether this or future increases in interest rates would act as a barrier to those seeking to get into the housing market.  The mortgage financing “stress test” — is likely one that is unfamiliar to most Canadians, even those who are affected by it.

When anyone seeks to borrow money, a key factor in determining their ability to obtain a loan is, their ability to repay the loan/That same consideration applies when an individual or a couple apply for approval or pre-approval of a mortgage.

In determining whether a borrower will be able to repay the mortgage loan as required, mortgage lenders rely on two debt-to-income ratios, known as Gross Debt Service (GDS) and Total Debt Service (TDS). The two are similar, but not the same.

The GDS ratio measures how much of the would-be borrower’s income will be needed to meet his or her housing costs. For any borrower, GDS represents the total of mortgage payments, property taxes, heating costs, and — where applicable — one-half of condo fees. Optimally, that total figure will represent less than 35% of the would-be borrower’s income.

Of course, most Canadians carry one or more kinds of consumer debt besides their mortgages, and so it’s necessary to determine their cost of servicing that total debt as a percentage of income. That figure is their TDS, which is the total of housing expenses (as calculated for purposes of GDS) plus any other debt repayment, including car loans, credit cards, lines of credit, and student loans. Optimally, the total amount of housing costs plus other repayment will be less than 42% of the would-be borrower’s income.

Where a would-be borrower is particularly credit-worthy (e.g., he or she has a reliable source of income and a good credit history), lenders will provide mortgage financing even where the optimal debt ratios indicated above are exceeded. However, the maximum GDS and TDS ratios allowed are, respectively, 39% and 44%.

While the GDS and TDS ratios do provide a reasonable measure of the ability of a prospective borrower to repay funds advanced to him or her, the weakness of those ratios are that they provide only a “snapshot” of the individual’s housing costs and debt repayment costs at a point in time and, more significantly, at current interest rates. As everyone knows, interest rates in Canada are, and have been for several years, at or near records lows and that many Canadians have taken advantage of those low rates. Specifically, as of the first quarter of 2017, the average debt load of Canadian households (including mortgage debt) stood at 167.3% of disposable income.

The combination of those two factors means that Canadian households are, on average, carrying much higher levels of debt (as a percentage of disposable income) and that the cost of carrying such debt is at or near record lows. When, as has recently proven the case, those interest rates begin to rise, such increase has the potential to put Canadian households on financial thin ice. And that possibility is what gave rise to the introduction by the federal government of the “stress test” which might equally well be called the “what-if?” test.

Basically, the stress test requires that lenders assess a would-be mortgage borrower’s ability to manage their debt, not only at current interest rates, but at the higher rates which those borrowers will certainly face sometime during the life of their mortgage. Carrying out a stress test is, in fact, something which financial planners advise clients to do as part of financial planning whenever taking on debt is contemplated. It’s simply prudent (especially where debt is longer term in nature and consequently higher payments resulting from an increase in interest rates is inevitable) to consider, not just whether the debt is manageable at current interest rates, but whether it will remain manageable where those interest rates rise by 1, 2, or 3% — or more. The “stress test” simply creates a requirement out of something that was always a good idea.

It’s true that the application of the “stress test” as interest rates rise will cause more borrowers to be unable to qualify for a mortgage, or will require them to reduce their expectations in terms of the amount of mortgage financing for which they can qualify. But, it’s also the case that would-be borrowers who cannot “pass” a stress test are the very borrowers who would be put most at risk by an increase in interest rates. Where interest rates will be a year or two from now is something that no one — including the Bank of Canada — knows. It is undoubtedly disappointing for would-be borrowers to have to reduce their expectations with respect to the amount of mortgage financing (and therefore the “amount” of house) they can obtain. That scenario is, however, infinitely preferable to one in which they discover down the road that they can no longer afford to carry their mortgage at the higher interest rates then in effect, and are at risk of defaulting on that mortgage and potentially losing their home.

CRA Suspends Audits on Charities’ Political Activities

072826_Thinkstock_186059084_lores_ABMany Canadians are generous in their gifts to charity, and in return, they may receive tax benefits. In recent months, there’s been some loosening of the restrictions placed on charities, which may be of interest to contributors.

While Ottawa was in the hands of the Conservative Party led by Stephen Harper, the government put strict restrictions the political activities of charities in 2012.

Five years later, Canada Revenue Agency (CRA), under the current Trudeau-led Liberal Party government, said it is suspending audits of political activity by charities. The move comes after recommendations by a panel the CRA commissioned to study the issue. The panel’s 2017 report urges the government to “broaden the ability of registered charities to engage in political activities,” while at the same time maintain “an absolute prohibition on partisan political activities.”

The five-member panel said that one particularly strong message emerging from the feedback it received during consultations was that a lack of clarity meant that some charities view political activities as too risky and engage in self-censorship. Without knowing the exact parameters within which they can operate, and given that the penalty for even an accidental breach of the rules may be deregistration, many charities make a rational choice to avoid or limit the risk.

Furthering a Group’s Charitable Purpose

The panel recommended that a charity’s political activities, whether pressing for a change in government policy or buttonholing a politician, be judged on whether they further the group’s charitable purpose. The panel proposes eliminating current rules that restrict a charity’s political activities to 10% of its resources.

One of the panel’s key recommendations was that the CRA revise its policy guidance to explicitly allow charities to:

1. Provide information to others related to their charitable objects (including the conduct of public awareness campaigns) for the purpose of informing and swaying public opinion. Such information must be truthful, accurate and not misleading.

2. Conduct research, distribute it to others and discuss the research and its findings with the media and others as they see fit.

3. Express opinions on matters relating to their charitable objectives, as long as they draw on research and evidence and don’t impinge on hate laws or other legitimate restrictions on freedom of speech.

4. Encourage keeping or changing law or policy, either in Canada (on any level of government) or outside of Canada.

5. Call on supporters or the general public to contact politicians of all parties to express their support for, or opposition to, a particular law or policy.

6. Make written or verbal statements to elected officials, parties and candidates, and release such materials publically. The adoption of a charity’s policy by a political party doesn’t in itself constitute partisan political activity.

7. Invite competing candidates and political representatives to speak at the same event, or request written submissions for publication, provided that candidates and parties are given an equal opportunity to speak or have their views published.

8. Express their views and offer others opportunities to express their views, on social media or elsewhere provided such platforms are monitored and partisan political messages are removed.

The panel also encouraged the CRA to:

  • Remove the requirement that a charity’s materials must reflect all sides of the argument, and add that they must be fact-based, and
  • Amend CRA Form T3010, Registered Charity Information Return (annual report) to remove the requirement to quantify resources used for political activities, and replace it with one to describe, in narrative form, the nature of the public policy dialogue and development work undertaken.

Expansive View of Charitable Activity

The panel went on to say that, in its view, the CRA could find support for a broader view of what constitutes charitable activity in case law.

For example, the 1999 Supreme Court ruling in Vancouver Society of Immigrant and Visible Minority Women v. Minister of National Revenue supports looking at the activity in the context of a charitable purpose. If a charity calls for a change in the law in furtherance of its charitable purpose — and such activity is subordinate and non-partisan, the panel said it believes the policy could accept it as charitable.

The panel noted that it believed such an expanded view would go a long way in providing clarity to the charitable sector and would enable it to more meaningfully contribute to public policy reform. Moreover, the panel said, it would remove the current disadvantage faced by the charitable sector in relation to for-profit companies, which can advocate in the public policy arena without restriction.

The panel also urged the CRA to list examples of what will be considered partisan political activities to replace the prohibition on both “direct and indirect” partisan political activities, which the panel suggested is highly subjective (particularly “indirect”), and has been the subject of much confusion.

Need for Legal Changes

Feedback on another issue was clear: fundamental legislative change is needed, and new policy or other administrative measures won’t be sufficient. Suggestions from the panel included:

  • Adopt an inclusive list of acceptable charitable purposes in the Income Tax Act that reflects contemporary society, its issues and expectations.
  • Consider the approach of other jurisdictions, some of which have softened restrictions on political purposes.
  • Clarify that public policy activities (for example, research, dialogue, advocacy, and calls to action) are charitable, provided they’re non-partisan and subordinate to a charitable purpose. In other words, accept the Supreme Court of Canada decision from the Vancouver Immigrant Society case and incorporate it in future legislation (that an activity is considered in the context of the charitable purpose).
  • Create a permanent mechanism for consultation with the charitable sector to ensure an ongoing process for developing policy guidance.
  • Enable charities to benefit from social enterprise and social finance models.

The CRA said the suspension of charity audits will be in effect until the government officially responds to the panel’s report.


CRA Aims to Boost Services for Small and Medium-Sized Businesses

071417_Thinkstock_521090040_lores_kwSmall- and medium-sized businesses will be getting more help from Canada Revenue Agency (CRA) over the next couple of years.

The tax agency recently unveiled plans to make its services for those businesses more helpful and easier to use. The new plan follows consultations started in October 2016 and follows separate consultations in 2012 and 2014. The agency met with businesses, accountants and CRA employees who regularly interact with businesses, and also accepted feedback online and discussed issues with business associations.

“The vast majority of Canadians do everything right.”

— A CRA employee

The result is a program called Serving You Better. The CRA received more than 1,500 comments and suggestions. Here is a summary of the new initiative taken from the CRA website:

Making Tax Information Easier to Access, Understand and Use

Participants told the CRA they don’t like busy signals when they call and they do like services with a call-back option. Accountants want to ask complex questions on the phone. Businesses would like an auto-fill option and to be able to complete more tasks online.

The CRA said it will:

  • Switch over to the Government’s telephone platform and complete feasibility studies for adding call-back and secure chat lines.
  • Conduct a pilot for a service dedicated to letting tax preparers call experienced CRA staff members who can help with complex technical issues.
  • Review the Pensionable Insurable Earnings Report (PIER) and other notices and letters for businesses. Let corporations see the assessed value of income tax returns and schedules as well as their CRA-verified dividend account balances in My Business Account.
  • Expand the Liaison Officer Assistance Requests pilot program to allow businesses across Canada to request a Liaison Officer visit. Start an auto-fill option using commercial software.
  • Study the possibility of setting up a volunteer tax program that would help the smallest new businesses understand the payroll, GST/HST and other tax obligations that come with starting a business.
“My clients and I are frustrated that we aren’t able to obtain remittance forms online.”

— An accountant

Clarifying Information about Payment Options

Participants noted that payments don’t always go where they expect. Although there have been improvements, individuals said they still had concerns about these errors and the time it takes to resolve them.

The CRA said it will:

  • Improve the way it explains how to fix misallocated payments when and where taxpayers want.
  • Raise awareness about direct deposits into taxpayers’ bank accounts.
  • Make payroll remittance vouchers easier to order online.
  • Explain clearly how remittance vouchers are personalized to ensure payments go to the right accounts.
“Objections are a nightmare just to get assigned.”

— From an accountant

 Improving Services Related to Audits, Collections and Appeals

Taxpayers and accountants were clear about how unhappy they are with the amount of time it takes to resolve any objections. They want better communications between their businesses and representatives and CRA auditors.

The CRA said it will:

  • Improve the time it takes to resolve an objection (it developed a plan to improve timeliness and better inform Canadians of the expected and actual time frames for resolving an objection based on its complexity.
  • Improve audit processes and communications through a post-audit survey and by monitoring the feedback it receives.
  • Enhance the clearance certificate process by communicating earlier when you apply and by helping businesses identify situations when a certificate isn’t required.
  • Ensure consistency by communicating collection procedures to audit branches and offering training for auditors.

The CRA notes that it has previous consultations on cutting red tape in 2012 and 2014. As a result, the tax agency says it already has:

1. Introduced the Liaison Officer initiative.

2. Engaged associations including the Canadian Payroll Association and the Chartered Professional Accountants of Canada (CPA Canada) to identify CRA guides and forms needing to be simplified and clarified.

3. Reduced the payroll remittance burden for the smallest new employers.

4. Allowed businesses to request a payment search using the My Business Account Enquiries Service and to submit cashed cheques as proof of payment using Submit Documents.

5. Included a My Audit tab in My Business Account that allows electronic communications between businesses and auditors.

6. Provided a streamlined Interactive Voice Response system that makes it easier for business callers to connect with an agent.

7. Introduced training to help auditors become more sensitive to the needs and realities of small and medium businesses.

8. Reviewed completely its notices and letters to make them clearer and easier to understand.

9. Reduced the need for callers to repeat information when a call is transferred from one agent to another.

10. Set up a way to connect callers to the right expert.

Top 10 Things You’ll Be Able to Do

The CRA’s 2017-2019 Serving You Better action plan contains over 50 action items that the agency expects will improve services for small and medium businesses.

According to the CRA, here are the top 10 things you’ll be able to do:

1. Receive a CRA security code by email

2. Call a new dedicated telephone service for tax preparers that helps with more complex technical issues

3. Request a Liaison Officer visit

4. Provide T4 information slips to your employees in electronic format (certain conditions apply)

5. Use T2 Auto-fill through commercial software

6. Create your own filing and balance confirmation letters online

7. View short “how-to” videos that explain the services on My Business Account

8. Experience telephone service improvements

9. Share feedback about your audit experience in a new post-audit survey

10. Have your objections resolved faster

Canada: Fifth Most Millionaire Households Yet Many Are Buried in Debt

070717_Thinkstock_452678211_lores_kwCanada moved up to fifth place from eighth of countries with the most millionaire households in 2016, according to a recently published report by Boston Consulting Group (BCG).

And yet, the Bank for International Settlements (BIS), Bank of Canada and other organizations have recently expressed concern about the country’s debt problems.

Warnings About Debt

The BIS, which serves as a bank for central banks, is flashing warning signals that mean Canadian debt has reached critical levels, and will likely result in a financial crisis. The BIS notes that the gap between credit consumption and economic output (gross domestic product) has reached a critical 14.1 level in Canada.

That gap measures the risk associated with the credit given to households and businesses in a country. The BIS considers anything above 2 to be a strong gap, and anything above 10 to be a critical warning. Breaching 10 results in a banking crisis in two-thirds of economies within three years.

More locally, the Bank of Canada recently warned that Canada’s financial system is becoming increasingly exposed to economic shocks as household debt levels continue to climb and major housing markets remain hot. The central bank noted that highly indebted households have less flexibility to deal with sudden changes in their income.

“As the number of these households grows, it is more likely that adverse economic shocks to households would significantly affect the economy and the financial system,” the bank said.

And while it seemed Canadians were ignoring its warnings about high household debt, the central bank posted a video on YouTube explaining how the dangerous combination of debt and inflated house prices could lead to recession or worse.

Statistics Canada also recently confirmed that many Canadians are drowning in debt. The agency said Canadians owed $1.67 in consumer credit, mortgages and non-mortgage loans for every dollar of household disposable income in the first quarter of 2017. That was a slight quarterly decrease as household net worth rose from the end of 2016.

It’s interesting to note that despite the high debt levels, most Canadians don’t appear to be defaulting. Credit agency TransUnion says that the 90-plus day non-mortgage account delinquency rate in the first quarter of 2017 dropped to 2.72%, down nearly 1.5% from the year before.

Back to the Wealthy

Meanwhile, Canada’s richest households control an ever-growing share of the country’s wealth. According to the Fraser Institute, a nonpartisan research and educational organization, the top 20% of Canadians own about 67% of the country’s wealth and the bottom 20% own none. But what accounts for this inequality? Not necessarily hard work or large inheritances.

“A deeper understanding of the statistics reveals the vast majority of wealth inequality in Canada is simply due to differences in people’s age and the fact that people accumulate more wealth as they get older. In other words, wealth inequality is largely a fact of life,” the Fraser Institute says.

Meaning that the wealth gap in Canada is explained by people’s stage in life.

But that doesn’t help if you’re saddled with debt, whether you make more than $500,000 a year or less than $30,000. What can you do about it? Here are a few suggestions.

Getting Out of Debt

The first step is to calculate your debt situation. Your financial advisor can help with this. One way is to find your debt-to-asset ratio. This measures what you owe (liabilities) to what you own (assets). Add up your mortgage, car loan, lines of credit, credit card debt and anything else you owe. Then tally your total assets, including the appraised value of your home, savings and investments including Registered Retirement Savings Plans and Tax Free Savings Accounts, and any other property that’ll grow or retain its value.

Divide your debts by your assets and multiply by 100. You want a low ratio. For example, if you owe $300,000 and have $75,000 in assets, your ratio is 400%. But if you owe $75,000 and have $300,000 in assets, the number is a much smaller 25%.

Then, regardless of how much you earn, consider these ways to control your spending, manage debts wisely and, if necessary, reduce your liabilities:

Create or review a budget. This will help you figure out how much money you take in, spend and save. It’ll also help you balance your income and regular expenses as well as guide you toward your financial goals.

Organize. Take stock over everything you’re spending money on each week. Keep receipts in order to help you get a handle on where your money is going. Pay yourself first, through auto-deposits into savings accounts or retirement/pension plans.

Distinguish between want and need. This can help you reduce expenses for what might be frivolous things such as a sports car you’ve been eyeing, extra cable channels or that big-screen 4K television set. Make spending choices based on what you need — not what the TV ads or signs in shop windows say you need.

Review your automatic payments. You may be paying for things you no long use, such as club or gym memberships, newspapers or magazines. Stop these immediately.

Shop for bargains. You can usually find ways to cut costs, whether it’s the kids’ clothes, dental checkups, car wash, books you could get at the library instead of purchasing them or bulk food instead of expensive premium brand food.

Avoid late fees. Save yourself extra fees and expenses by paying bills before they’re due or set up auto-payments at your bank for what you actually use.

Decide which debts to pay off first. By paying off the balances with the highest interest first, you’ll pay less interest. This will help you become debt-free sooner. List your debts in order from the highest interest rate to the lowest. Make the minimum payments on all your debts. Then, use any extra money to pay down the highest interest debt.

You may want to start with your debt with the lowest balance. You may feel an accomplishment by paying off a debt. This can keep you motivated to maintain your goal of becoming debt-free. However, this option may cost you more in interest over time.

Work with your creditors. Contact creditors to discuss your financial situation. They may offer such solutions as:

  • Lowering the interest rate on your debt,
  • Extending payments over a longer period of time, or
  • Reducing your minimum monthly payment.

Close accounts that are paid. Once you pay off a debt, consider closing it. One account with a low credit limit can be useful to maintain or improve your credit score. Keep only what you need and can manage responsibly. You may also want to consider using a secured credit card instead of a regular credit card. A secured credit card requires you to leave a deposit with the credit card issuer as a guarantee.

Lose the credit cards. There’s no easier or faster way for you to increase debt than using credit cards. Something about charging purchases makes many people think they aren’t increasing their debt. The best way to dispel this illusion and get your spending and debt under control may be to cut up credit cards.

Consolidate debts. If you have high-interest loans, consider taking out a single loan with a lower interest rate to consolidate your debt. This will mean you’ll only have to make one payment.

A consolidation loan may help you get out of debt, if it:

  • Has a lower interest rate than all your other debts put together, and
  • Has a lower monthly payment than all your other debts put together.

But be careful to not to use the credit that is freed up. If you can increase your payments on the consolidation loan, you’ll reduce your debt faster and pay less in interest. A consolidation loan won’t hurt your credit rating if you make the payments on time.

Consult with your financial advisor for more ways to manage your debt and build your net worth.

CRA Gets Tough On Real Estate Tax Cheats

062317_Thinkstock_501212115_lores_kwCanada Revenue Agency (CRA) says it has taken significant steps to address tax cheating in the real estate sector.

The CRA says that, in recent years, it has increased its real estate audits, particularly in the Greater Vancouver and the Greater Toronto areas, where increased real estate speculation has heated the market. From April 2015 to March 2017, CRA audits of real estate transactions scooped up more than $329.4 million in unreported taxable income.

Protecting Tax Fairness and Integrity

The feds have taken other measures to curb tax cheating in real estate deals. Specifically, in a change aimed at making sure only eligible home owners claim a principal residence exemption from paying taxes on capital gains, you are now obliged to report the sale of principal residences to the CRA. Before the 2016 tax year, if the property was your principal residence for every year you owned it, you didn’t have to report the sale on your income tax and benefit return.

National Revenue Minister Diane Lebouthillier explains, “For many Canadians, buying a home is one of their proudest moments and represents one of their most important investments. Our Government has committed to protecting the fairness and integrity of the tax system for all Canadians, notably by cracking down on tax cheating in real estate transactions. This means that, without exception, every taxpayer abides by the same tax laws.”

The CRA says it plans to enhance its ability to combat tax evasion and avoidance by strengthening relationships with such key partners as provinces, territories and municipalities to expand, obtain and exchange information on real estate transactions. The agency also seeks the help of taxpayers. If you suspect that someone hasn’t reported income or GST/HST related to a real estate transaction, the CRA urges you to contact the National Leads Centre. Your identity won’t be disclosed, and you can provide information anonymously. Your tax advisor can provide you with the details.

In the midst of the recent heated real estate market, questions have been raised about what federal tax obligations the buyers and sellers of real estate must meet, and how the CRA ensures tax compliance on these transactions.

The Key Areas of Compliance Risk in Real Estate

There are five main areas of concern:

1. Questionable sources of funds. The sources of funds used to buy or maintain Canadian properties could be an unreported spring of money that was never taxed, either in Canada or another country. In certain circumstances, a large down payment on a home, or a property that is expensive to maintain, may indicate:

  • Unreported income, if the lifestyle of the buyer isn’t compatible with the income reported,
  • Tax evasion, or
  • Purchase of real estate by a low-income person concealing a wealthy buyer.

The CRA can establish correlations between a taxpayer’s reported income and his or her lifestyle. The acquisition of expensive assets, such as a high-end home, without an obvious source of income, can be an indicator of potential unreported income earned from legal or illegal sources.

2. Property flipping. People, including real estate agents, who buy and resell homes in a short period for a profit are engaged in what is known as “property flipping.” There are three main categories of people engaged in this:

  • Professional contractors who sometimes demolish or renovate a property.
  • Speculators or middle investors who, for a profit, buy a property and assign the right to sell to another speculator or the final buyer. (This is called “shadow flipping” and it can occur many times between the first and final sale of a property. The original seller often doesn’t know that the property has been assigned to another buyer until the signing date.)
  • Individuals who buy real estate, renovate it, live in it for a short time and sell it to claim the principal residence exemption several times in their lifetimes.

The CRA acquires and analyzes third-party data and has found that some flips aren’t being reported or are being reported incorrectly. The profits from flipping real estate are generally considered to be fully taxable as business income, but there may be circumstances where they’re considered capital gains. The facts of each case determine whether such profits should be reported as business income or as a capital gain.

3. Unreported GST/HST. Generally, the builder of a new or substantially renovated home must charge and collect GST/HST when the home is sold and report that tax to the CRA.

If a builder leases a new or substantially renovated home, the builder is deemed to have sold the home to himself or herself. The GST/HST is payable on the fair market value of the home, including the land value, and the builder must report that tax to the CRA.

Generally, the deemed sale of a new or substantially renovated home isn’t considered to have occurred if:

  • A builder constructs or substantially renovates a home to be used primarily (more than 50%) as his or her place of residence, or a residence for a relative, and
  • The builder hasn’t claimed an input tax credit to recover any GST/HST payable for the construction or renovation

There may also be GST/HST implications for flipping transactions, if a property is new or has been substantially renovated. In most cases, the sale of used housing is exempt from GST/HST. One of the main conditions for the new housing rebate to be available is that you must buy or build the home as your or a relative’s principal residence.

If you buy or build a new home in Canada, but your principal place of residence is outside Canada, the house in Canada would be a secondary place of residence and wouldn’t qualify for the new housing rebate.

Also, if the intention at the outset is to flip the property, the eligibility requirement for the new housing rebate isn’t satisfied, as confirmed by several recent court decisions.

4. Unreported capital gains on the sale of property. Selling a property for more than it cost generally leads to capital gain. In most cases, capital gains are taxable and must be reported. Whether the gain is taxable depends on whether the property is a principal residence or whether the seller is a resident or nonresident of Canada. Consult with your tax advisor.

5. Unreported worldwide income. Residents must report their worldwide income. Nonresidents have to report only Canadian-sourced income, unless a tax treaty provides otherwise. Your tax advisor can discuss how residency is determined.

If you are involved in real estate, regardless of the degree, consult with your tax advisor to help ensure you are complying with CRA rules. And if for any reason you reported such income incorrectly, you advisor can help you file an amended return.