The Impact of Loss of Income
Unemployment rates in Canada hit a high of 13.7% during the first few months of COVID, a significant increase compared to the average of 5.6% in the past few years. So while roughly one in seven people in the Canadian labour force lost all employment income, many other Canadians experienced a reduction of income in some way (lower hours, reduced bonus, lost sales, etc).
For anyone that is self-employed or relying on variable forms of income (hourly workers, freelancers/contractors, people receiving bonuses, etc), lost income in 2020 will hurt how much mortgage they qualify for. For a large number of Canadians, this COVID Shortfall means potentially putting off a home purchase.
The COVID Shortfall
The COVID shortfall is a loss of purchasing power due to COVID-related income losses for up to 3 years.
In this recent article, we discussed how to calculate qualifying income if you rely on any form of variable income. Your qualifying income is usually going to be assessed by the lender as the lesser of your 2-year historical average or your most current year. Here’s an example of a Canadian who would be impacted:
Priya has been working for the same employer for the past 3 years and has a base salary of $80,000. She typically receives a 20% annual bonus. Unfortunately due to COVID, Priya will not be receiving a bonus in 2020.
As of September 2020, this is what her historical income looks like to a lender:
2018: $96,000 | 2019: $96,000
Her 2-year average of $96,000 is her qualifying income. However, let’s say Priya is planning on waiting until 2021 to buy. This is the historical income the lender will look at if she buys next year:
2019: $96,000 | 2020: $80,000
Her qualifying income is now $80,000 (no bonus) — the lesser of the 2-year average and the most current year. If you run our Perch Qualifier Tool, it will show you that a drop of $16,000 in qualifying income would reduce Priya’s purchasing power by around $74,000 (16%). Let’s say (and hope) things get back to normal for Priya in 2021 and she wants to buy in 2022. Her relevant historical income that the lender will look at will be:
2020: $80,000 | 2021: $96,000
Taking the 2-year average, her qualifying income is now $88,000. This amount is still lower than where she originally was in 2020.
Regardless of what happens with COVID, Priya won’t have the same purchasing power she had in 2020 until 2023 when her income returns to $96,000 in 2021 and 2022.
The Expected Impact of the COVID Shortfall
Priya’s situation relates to bonus income specifically. However, a decrease in purchasing power due to loss of income also applies to the following scenarios:
- Salespeople with lower commissions due to reduced sales
- Incorporated business owners who paid themselves less dividends as a result of lower-income
- Sole Proprietor Business owners who reported lower net income
- Hourly staff or contract workers who had to work reduced hours
A large portion of the Canadian workforce has variable income and could be affected by the loss of income if they were planning on buying a home in the next two years. According to Statistics Canada, over 45% of businesses responded to COVID by either reducing hours, cutting salaries, freezing bonuses or laying off staff. We think the impact on the housing market shouldn’t be underestimated. If the lender underwriting policies or regulations don’t change to accommodate this reality many Canadians will be facing, we expect the following will happen:
- Buyers will wait until their qualifying income comes back to the level they need to qualify for the home they want, reducing demand from buyers for 1 or 2 years.
- Homeowners wanting to sell their home in order to buy a new home will not be able to qualify, reducing the supply of resale homes and the demand for home purchases for 1 or 2 years.
But Wait, There’s a Window of Opportunity
“The reality is that we are coming up to an inflection point, where not acting within the next 5-7 months could affect home buyers for up to 3 years if they’ve experienced a loss of income in 2020.”
The reality is that we are coming up to an inflection point, where not acting within the next 5-7 months could affect home buyers for up to 3 years if they’ve experienced a loss of income in 2020. Determine if the inflection point affects you by quantifying the impact of your lower qualifying income in relation to your planned home purchase price. What do we mean by that?
If you qualified for a $750,000 purchase today and would qualify for $650,000 next year, but you weren’t intending to buy for more than $600,000 then your lower qualifying income has no impact. However, if you were planning to buy a $700,000 home and these scenarios do apply to you, you have until February-May 2021 to close your home purchase without an impact on your qualifying income. The date depends on when your income documents for 2020 are finalized (T4 is usually February, T1/NOA is typically May).