Last month the feds announced there would be some changes to lending requirements effective April 19th. At the time I acknowledged they were a step in the right direction, but largely dismissed them as too little and too late.
The last few weeks there have been lots of questions concerning exactly what the specifics were to these proposed changes, particularly the move to using the 5-year fixed rate as the qualifying rate. This weekend we starting hearing reports about some of the specifics.
Basically it boils down to variable and short-term fixed (less than five years) borrowers will be required to use the 5-year fixed posted rate (as per the Bank of Canada)… those borrowing fixed rate with terms five years or longer will see no change, and will be evaluated according their their contract rate (which could be well below the posted rate).
For those uninitiated, perhaps a little background into just what all these different rates are (posted, discount, contract, qualifying). Perhaps an example is in order, lets use BMO… on their mortgage rate page they list 5-year fixed as 5.39%, this would be their posted rate… but they also offer specials, and on that page they offer a 5-year fixed rate of 4.09%, this would be the discount rate. The contract rate is fairly straight forward, it’s whatever rate you agree to with the lender, hence whatever rate is used in your contract. Finally the qualifying rate is the number that determines how you borrow.
Say you want to go the variable route, so lets use the 5-year variable rate of 2.15%, that would be your contract rate and would dictate your payments. Under the new rules, even with variable rate mortgage, you can only for as much financing as the qualifying rate allows.. and the qualifying rate will be the 5-year posted rate (currently 5.39%). So even though you’re borrowing at 2.15%, the amount you’re allowed to borrow is determined using the much higher rate of 5.39%. Lets take a look at what that does to the sums.
Lets say you make $75,000 a year, according to the new rules and a 5.39% qualifying rate, you could borrow a maximum of about $380,000… whereas if you used the 2.15% contract rate, theoretically you could have borrowed as much as $590,000. That’s a huge difference. So, under the new system while your payments will be determined by the contract price (as per usual), how much you can borrow is limited by the qualifying rate. So like I said, it’s a step in the right direction… unfortunately still far too little and much too late.
It’s worth noting that apparently at least some lenders did use a qualifying rate higher than the contract rate with variable borrowers before, often a 3-year fixed rate, whether discount or posted I do not know (though I imagine it was the former). In any case, it was lower than what it will be as of April 19th.
One interesting feature of these changes is that for terms 5-years of longer, that allows the qualifying rate to remain as the contract rate… this will have an interesting effect, in that even though 5-year fixed mortgages will not be the cheapest route, but it will allow the borrower to borrow the most money, as the discount rate (or whatever is negotiated) would be used rather than the higher posted rate. So, using our earlier example, instead of only being able to borrow $380,000, you could instead borrow as much as $450,000 using the 4.09% discount rate instead of 5.39% posted rate.
In a highly inflated market as most of the country finds itself, this will serve to make the already popular 5-year fixed even more desired (at least among those who desire more house, which seems to be most). Even given the inflated valuations, normally I would consider this exception as alright… but in the environment of “emergency” interest rates, this was a window that would have been wise to have shut and just made everyone be limited by the posted rate.
Alas, the damage is largely already done and rates will be going up soon anyway… beyond that, there will be a big rush to beat the new rules, and then another to beat the interest rates and new taxes in the spring, so the last of the greater fools will be throwing themselves over the cliff anyway.
So, I guess it doesn’t really matter. Just smile and nod as they get whipped into a frenzy yet again… if you feel the need to drop some cash, treat your primary sex provider to a fancy dinner and a night on the town. Maybe if you really impress them they’ll be open to inviting a secondary one… though personally, I have enough trouble disappointing one at a time! Have a good week all!
Nice breakdown… living on the margins of affordability this change will have a tipping point effect.
Thanks for the explanation and I agree, the very short term planners will be tripping over themselves to get locked into a rate that will more than likely be higher (possibly much higher) when they have to renew 5 years later. They won’t plan for this though just as the Adjustable Rate mortgage crowd in the US gave no thought to what was going to happen when their Adjustable rates reset to higher levels down the road.
Well if what you say is true, then maybe I should try and sell at the peak of this upcoming frenzy and then sit tight with a rental. I bought when prices were at their lows in early 2009. Then the market picked up and has stayed fairly stable since. If there is another frenzy prices will jump yet again. Maybe I should try and make a buck.
Nonetheless anyone who bought once rates went down to near zero should start saving for their payments once they renew. Else pay down their mortgage right now.
My wife’s in HR and she sees tonnes of resumes (meaning high unemployment). Alberta is not going to pick up anytime soon and is sitting on the fence. Decisions are made based on oil and gas prices. If prices drop we could be back to square one.
@Ryan… Might want to talk that one out with the wife before you start throwing that out there for me and the minions around here. There could be gains to be had, but selling the house from under her and the subsequent divorce would wipe that out and then some.
As per those who took advantage of the low rates, it would be wise to live hand-to-mouth and pound money into the mortgage as quickly as possible. It may seem like a poor return on investment now, but come renewal time it will pay dividends and could save a lot of people from financial ruin.