Increase to the Bank of Canada’s Qualifying Interest Rate
The Bank of Canada’s 20bps qualifying interest rate increase took effect Sunday April 8th, 2012 at 11:59pm and currently sits at 5.44 per cent. This is one more tactic implemented to dampen the spending habits and enlarged credit balances Canadians are facing. To keep up to date on key economic figures, check out RatePulse!
So what does this mean for you? Although you might be applying for a low rate (like a 5 year variable rate mortgage priced 20bps under prime, or a 1 year fixed rate at 2.39 per cent), your Gross Debt Service (GDS) and Total Debt Service (TDS) ratios are still calculated based on the qualifying rate. Yes this does make it harder to get approved, but it really benefits all parties involved in the mortgage!
What Qualifying Rate Do Underwriters Use to Qualify You?
Short answer? It depends. If you’re applying for a variable rate mortgage, the Bank of Canada’s qualifying rate is most commonly used. If you’re applying for a fixed rate, it depends on a variety of factors based on the lender.
Some lenders will decipher your qualifying rate based on whether your mortgage is considered high ratio or conventional. Generally speaking if your mortgage is considered high ratio you will be adjudicated using the BOC’s qualifying rate or the greater of your contract rate and the lender’s 5 year posted rate. Whereas with a conventional mortgage lenders will either use their 5 year fixed posted rate, their 3 year fixed posted rate or consider the greater rate between your contract rate and the posted rate.
Another method used by underwriters is they consider the term of your mortgage. If you have a term that is 5 years or greater, you can use your rate to calculate your debt servicing ratios. However, if you have a term that is less than 5 years you are looking at the BOC’s benchmark rate.
Using a Higher Rate to Qualify Benefits Everyone!?
Using a rate that is higher than your contract rate quite obviously benefits the lender since they are covering their tails and mitigating some of the risk involved in deciding whether or not you will be able to sustain mortgage payments in the future. They want to ensure that if/when rates increase (especially in the case of variable rate mortgages, which are designed to fluctuate with changing market conditions), your ability to pay off your mortgage is not compromised.
Inflating the qualifying rate also provides a form of insurance to you, the borrower, for the same reasons. Think about it…let’s say you were approved for a 3 year fixed mortgage at 3.39 per cent and your ratios were brimming at 32/42 GDS/TDS at the time of approval. Based on a $300,000 mortgage and 25 year amortization, your monthly payments work out to be $1,480.45. At maturity your balance will be $275,834.68, however over the last 3 years interest rates have increased. Now a 3 year fixed rate sits at 4.25 per cent and your new monthly payments are $1,604.46 (nearly $125 higher), plus your property taxes have increased, you have baby number two on the way, and your 15 year old vehicle is ready for the junk yard. You wouldn’t be in such a bind if you were originally qualified (and perhaps declined) with a higher rate.
This month’s panel of mortgage experts think that fixed rates will increase and variable rates will remain unchanged.
The ideas behind the nearly unanimous outlook of an increase to fixed rates include: the upward trending bond yields (due to global economic uncertainty) which would signal similar movements to fixed rates, the end of the mortgage pricing war, and the unsustainable profit margins that the 2.99 environment created.
The mortgage panel agreed upon no changes to the variable rates based on the idea that the overnight lending rate will not be changed next week (following a rate announcement on April 17th from the BOC). Variable rate pricing is thought to stay in and around prime. Recovery in the Canadian market has been slow, inflation has been stable, and the U.S. Federal Reserve isn’t looking to increase their rates until 2014. This surely explains why Carney is limited to implementing changes and must keep Canadian interest rates in check with the American (rock bottom) rates.
RateSupermarket.ca Week in Review
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Over the last week there were no big movements in the best mortgage rates. In fact, all of the rates remained unchanged with the exception of the 5 year variable rate mortgage which actually decreased by 5bps.
More and more people have moved away from searching the 5 year closed fixed and variable rates over the last week, although they remain the top two hottest searches. An increasingly number of RateSupermarket.ca’s visitors are searching the 10 year fixed rate (7.3 per cent), the 3 year fixed rate (4.8 per cent) and the 4 year fixed rate (4.4 per cent).