Why you qualify for less going with a variable: Qualifying for fixed/variable


One of the more common questions I get asked is fixed or variable?  Which is better?  Well, qualifying for the 2 is not the same so the first question you should ask is, do I qualify for both fixed & variable because it is more difficult to qualify for a variable than a fixed rate.

A variable rate mortgage has more risk than a fixed rate.  Because your rate & payment fluctuates, the bank wants to make sure that, when rates go up, you have enough income to cover that increase.  So when you qualify for a variable, instead of basing the formula on that juicy low variable rate of 2.2%, they’re going to use the 5 year qualifying rate, which is 5.49%.

That’s quite a difference in rate.  I want to give you an idea of what those numbers mean, so let’s say you earn $60,000, have no debts &, for illustrative purposes, we’re going to ignore the costs of ownership like taxes, heat, strata fees, etc.

Qualifying with today’s best 5 year fixed of 3.69%, <20%, on a 25 year, you would be eligible for a mortgage of roughly $340,000.  Now, using those same numbers, going with a variable & using the qualifying rate of 5.49%, that same client is eligible for a mortgage of around $285,000 – 15% less.

So this is important to know.  If you’re looking at homes in the north end of your affordability range, you may not have a choice.  A 5 year fixed may be the only way you can purchase.

Now, you do get a break if you have 20% down or more.  Because you have more equity in the home, most lenders allow you to qualify using the 3 year posted rate, not the 5 year, which will improve your qualification limit.

To find out how much you qualify for going with a fixed or variable, contact me.

Ryan Zupan
Mortgage Planner
604.250.6122
[email protected]

 

What controls fixed rates?

Hi, Ryan here with the Mortgage Centre City Wide. I know we’re really going through the basics here & breaking down the topics of these videos to their most basic form, but a fixed rate mortgage is really, well, very simple. Your interest rate & mortgage payment are fixed throughout the length of your term. Of course, you can fix your payments at a higher level, but that minimum monthly amount & the rate that’s based off of are fixed for your term.

So, I think a better topic here is explaining what drives your fixed rate mortgage, or, how do banks determine their 5 year mortgage rate. Remember, in my video on what controls your variable rate, we learned that the Bank of Canada is in the drivers seat. Well, fixed mortgage rates are determined by the market & are based off of government bond yields. Why?

After mortgages are arranged, they are packed up & sold on the markets as Mortgage-Backed Securities (MBS). These investments are similar to government bonds and actually compete against each other as low-risk investments. So when the yield on the 5 year bond increases, investors are attracted away from Mortgage Backed Securities to the corresponding bond because, now, the bond has a higher yield. To become more competitive, then, lenders will increase fixed rates & vice versa.

So the final question we have here is why do bond yields increase or decrease? The coupon for the bond, or the income that bond produces, is fixed, so why would someone want to pay more or less for that fixed income?
Well it’s driven by supply & demand. When the stock market is in turmoil, people want a safe place to put their money, so they may go after bonds. The more people wanting to buy bonds, the higher the price increase &, in turn, the more the yield decreases.

This is probably getting into another topic but bond yield & price have an inverse relationship. All you really need to know is when the markets are volatile, the yield on bonds decrease & therefore fixed rates will decrease. On the other side, when the markets are strong, investors are attracted away from bonds, their price decreases, yield increases, as will fixed rates.

Now typically, the spread between the bond yield & the corresponding fixed rate is 1.2 — 1.4%, but fixed rates are kind of like gas prices, they’re quick to go up but slow to trickle down. So if you want to get an idea of when 5 year fixed rates are going to increase, keep an eye on the 5 year bond yield. Or call me.

Ryan Zupan
Mortgage Planner

What controls variable rates?

Last week, we went over what is a variable rate. Today we’re going to go one step backward & explain where that variable rate comes from.

Going with a variable, you are opening up your mortgage to a lot more risk than with a fixed rate. Of course, because your rate changes throughout the year, there is no limit to how high this rate could go throughout the term. So, it’s very important for those going with a variable, to understand who or what controls Prime Rate & how they can get an idea of where their rate is going throughout the term.

Your variable, remember, is tied to the bank’s prime rate, so what determines prime rate?

Prime rate is controlled by the Bank of Canada’s overnight rate; they are directly related. 8 times per year, the Bank of Canada announces whether they will increase, decrease or leave target for the overnight rate unchanged. This is an important announcement for those with variable mortgages because this will tell you what’s going to happen to your mortgage for the next month or two.
Why would the Bank of Canada change the overnight rate, or in turn, Prime Rate?

This is really a tool the Bank of Canada uses to control inflation & the economy. When the economy is strong & the price of goods is increasing, inflation begins to happen. To try to slow down inflation, the Bank of Canada will increase this rate to get the economy under control. Higher interest rates means it’s more expensive to borrow. When it’s more expensive to borrow, you can expect less borrowing to happen, so less stimulus to the economy.

On the other hand, when the economy is slow, as we saw the Great Recession beginning 2007, the Bank of Canada wanted to encourage borrowing to ignite the economy. In this case, they lowered the target for the overnight rate to make it more attractive to borrow. Lower interest rates means it costs less to borrow. If I’ve been holding off on buying, when the government lowers that rate, it might just be enough incentive for me to take out that business loan, or buy a house, or whatever; it’s more attractive for me to borrow.

So with your variable rate mortgage, Prime Rate is not some magic number your bank uses to punish you or anything like that, it is determined by the Bank of Canada, which is basing its decision on the economy.

If you’d like to know more information on this topic or if you’d like to know where economists are predicting prime rate to go over the next 2 years, contact me.

Ryan Zupan
Mortgage Planner