By Calum Ross
With the spring housing market now behind us and bidding wars simmering down, it’s the perfect time to buy a home. Despite rising real estate prices in the most sought-after housing markets like Calgary, Toronto and Vancouver, mortgage rates have never been more affordable, making this one of the single best times to borrow – quite literally in all time. Today you can find a variable rate mortgage at the bargain basement price of 2.10 percent, a steal of a deal historically speaking. This is in sharp contrast to the 1970s and 1980s, which saw homeowners walk after from their homes in droves when mortgage rates went above 20 percent.
When it comes to mortgages, there’s a lot of mortgage lingo to learn. While most people understand what a mortgage amortization and term are, fewer people seem to know mortgage rate lingo. There are three important rates every real estate investor should know: posted rate, discount rate and qualifying rate.
The posted rate is the rate advertised by a bank. Similar to the sticker price on a new car, you should very likely not take the posted rate. Instead, you should try to negotiate the posted rate down to a lower rate without the loss of key privileges. Generally speaking – like other things in life - if it seems too good to be true it usually is. The lower mortgage rate you end up accepting is known as the discount rate. Last but not least, the qualifying rate is the rate used by mortgage lenders to determine the size of your mortgage for qualification purposes.
While variable mortgage rates may be lower than fixed mortgage rates, qualifying for a variable rate mortgage is another story. Once upon a time, qualifying for a variable rate mortgage was no different than fixed. That all changed April 19, 2010, when the federal government decided to intervene in the housing market via mortgage lending (otherwise referred to as credit capital markets). In an effort to avoid a U.S. style housing crash, the government made it more difficult to qualify for variable rate mortgages (and fixed rate mortgage terms under five years). This was done to make sure homebuyers didn’t get in over their heads
When you’re applying for a five-year fixed rate mortgage, what you see is what you get. Your qualifying rate is based on the mortgage rate you get from the bank. For example, if you get a five-year mortgage at 2.49%, your qualifying rate and how much you can borrow is based on that. Things are a little different with the five-year variable rate mortgage. With the variable rate mortgage, the qualifying rate is based on an average of the inflated posted rates of the big six banks. As we’ve seen, the posted rate can come back to haunt us on the mortgage penalty for fixed rate mortgage, but it also makes it harder to qualify for variable rate mortgages.
Let’s run through an example to show the difference between fixed and variable mortgages. If you purchased a home for $500,000 with 20 percent down, you’d be left with a mortgage of $400,000. If you chose a five-year fixed rate mortgage at 2.48 percent, your payment would be approximately $1,800 per month, but if you chose a five-year variable rate mortgage at 2.25 percent (prime less 0.6 percent), your payment would be only $1,742 per month. But that’s not the end of the story.
Under the fixed rate mortgage, the qualifying rate would be 2.48 percent, but with the variable rate mortgage your qualifying rate would be based on an average of the posted rate of the big six banks. For example, if the average is 4.99 percent, you’d have to prove you could afford a mortgage payment of $2,324 per month. Does the variable rate mortgage still seem as appealing? The reason for the tougher qualifying rate is simple – the government wants to make sure you could handle a jump in interest rates. Even though interest rates may stay put or drop, you still have to prove you could handle a sudden jump.
With bond yields on the rise as of late, now is the time to lock into a five year fixed from a timing standpoint. If you’re in the market for a fixed rate mortgage, now isn’t the time to take your sweet time. For those sitting on the fence, get a rate hold now to protect yourself from higher mortgage rates and tighter lending rules on the way.
Calum Ross was ranked as the top producing mortgage broker in the country by Canadian Mortgage Professional Magazine. He holds both a B.Comm and MBA in Finance and recently completed a comprehensive Leadership Program at Harvard Business School. Reach him at: www.calumross.com.