Fixed vs Variable Rate Debate
I have received a lot of questions regarding the difference between fixed and variable rates. What are they based on? Do they both move at the same time? Why is it harder to qualify for a variable? All great questions, and all questions that you need to be clear on before signing into a mortgage contract. Fixed mortgage rates follow the pattern of Canada Bond Yields, plus a spread, where bond yields are driven by economic factors such as unemployment, export and inflation. Variable mortgage rates are driven by the same economic factors, except variable rates fluctuate with movements in the prime lending rate, the rate at which banks lend to their most credit-worthy customers. Variable mortgage rates are typically stated as prime plus/minus a percentage discount/premium. For example, a variable rate could be quoted as prime - 0.8%. So, when the prime rate is, say, 5%, you will pay 4.2% (5%-0.8%) interest.The Bank of Canada adjusts the prime rate depending on the state of the economy, as determined by the economic factors introduced above. Together, combinations of unemployment, export, and manufacturing values shape the inflation rate. Generally speaking, when inflation is high, the Bank of Canada will increase the prime rate to make the act of borrowing money more expensive. Conversely, when inflation is low, the Bank of Canada will decrease the prime rate to stimulate the economy and improve the attractiveness of borrowing.In terms of the discount/premium on the prime rate applied to variable rates, mortgage lenders set this based on their desired market share, competition, marketing strategy and general credit market conditions. These are the same factors that drive the spread between lenders' fixed mortgage rates and bond yields.Qualifying for fixed and variable rates has changed over the last couple of years. Before I break down the differences in qualifying, let's talk about the Benchmark rate in Canada. The benchmark rate is a rate that lenders are required to use to qualify mortgage borrowers in Canada who want a variable rate mortgage or a fixed mortgage term of less than 5 years.The purpose of using a qualifying benchmark rate is to ensure that those who qualify for a mortgage in Canada can qualify with breathing room. In the event of a downturn in the economy or increase in rates down the road, this prevents Canadians from becoming orphaned homeowners without a lender willing to assist them. We are in an era of all-time low interest rates, so the sad reality is they have nowhere to go but up. Purchasing a home at a rate of 2.99% looks amazing today, but the payments can be substantially higher when you renew in five years at 5.5%. This is something referred to as 'Payment Shock'. (To be discussed in an upcoming newsletter... hint hint, watch for it!) Our Minister of Finance, Jim Flaherty, deemed it necessary that all fixed 1, 2, 3, and 4 year, and all variable mortgages qualify at the benchmark rate. The benchmark rate in Canada is currently set at 5.34%. This translates to buyers affording less because of inflated interest rates that act as a safety net.The only way to avoid qualifying at the Benchmark rate is to opt into 5 to 10 year fixed terms. These terms allow you to qualify at the contract rate (the rate being offered by your Mortgage Advisor). The difference in the contract rate and the benchmark rate can be very significant. Here is an example:Suzie and Charlie want to purchase their first home. After speaking with their Mortgage Advisor, they are given two options:1. $400 000 with the 5 year fixed at 3.59%, or2. $335 000 with the 5 year Variable at Prime-0.4% (2.6%)Even though option 2 has a lower interest rate, it needs to be qualified using the Benchmark rate (5.34%), so their purchase becomes noticeably less.To sum this up, fixed rates and variable rates are two completely different products and are actually very independent of one another. I understand this can be a very confusing topic, so don't hesitate to contact me with your questions!
Professionals who can help you with home buying
Because purchasing a home is probably the biggest investment you will ever make, youll definitely want a team of professionals working with you throughout the process.
The Real Estate Agent
Helps you find the ideal home
Writes an Offer of Purchase
Negotiates on your behalf
Gives you important information about the community Can help you plan the home inspection
A lawyer (or a notary in Quebec) protects your legal rights. He or she will review all contracts before you sign them, especially the Offer (or Agreement) to Purchase. Remember that a lawyer/notary should:
Be a licensed, full-time lawyer/notary
Be local and understand real estate laws, regulations and restrictions Have realistic and acceptable fees
Be able to explain things in plain language
The Home Inspector
Performs an inspection of the visible components of the home
Tells you the condition of the house; what is working properly; what needs to be changed; what is unsafe; and what repairs need to be made
Can tell you where there may have been problems in the past
Usually belongs to a provincial or industry association
A good credit report and credit score are important factors in determining whether or not you will be approved for a mortgage. Here are some simple steps you can take to maintain a good credit history, and improve your chances of being approved.
What is a Credit Score
Your credit score is a number that illustrates your financial health at a specific point in time. It also serves as an indicator of your financial past, and how consistently you pay off your bills and debts. This is one of the factors mortgage professionals consider in qualifying you for a mortgage.
How to Check Your Credit Score
To find out your credit score, contact Canadas two credit-reporting agencies: Equifax Canada at www.equifax.ca and TransUnion Canada at www.transunion.ca. For a fee, these agencies will provide you with an online copy of your credit score as well as a credit report a detailed summary of your credit history, employment history and personal financial information on file. You can also obtain a free copy of your credit report by mail. If you find any errors in your report, notify the credit-reporting agency and the organization responsible for the inaccuracy immediately.
If You Do Not Have a Credit Score
Its important to begin building a credit history as early as possible. You can begin to build one by applying for and responsibly using a credit card. Your financial institution or mortgage professional can help.
How to Improve Your Credit Score
Demonstrating your ability to manage credit is key to maintaining a good credit score. There are a number of things you can do to improve your credit score. These include: Always pay your bills in full and on time. If you cannot pay the full amount, try to pay at least the required minimum shown on your monthly statement. Pay off your debts (such as loans, credit cards, lines of credit, etc.) as quickly as possible. Never go over the limit on your credit cards, and try to keep your balances well below the limits. Reduce the number of credit card or loan applications you make. Once your credit score has improved, work with your mortgage professional to obtain a mortgage that works for you.
Find Out More
To find out more about credit scores and reports, visit the Financial Consumer Agency of Canada website and download or request a free copy of their guide, Understanding Your Credit Report and Credit Score. This guide provides practical, straightforward information on how to obtain and understand your credit report and score, as well as how to build and maintain a good credit history.