Interest Rate And Your Buying Power - What Is The Impact Of Increasing Rates?
The story of 2018 was one of increasing interest rates and a tighter lending environment. I was recently asked - how much are buyers impacted if rates continue to move up? Your maximum mortgage is determined by two calculations. The first, called GDS (Gross Debt Service) is the percentage of your gross income going towards your housing costs, including the mortgage payment, property taxes, heating, and half of the condo fees. Under standard guidelines for an insured mortgage (less than 20% down payment) GDS can be no more than 39%. Your TDS (Total Debt Service) is the percentage of your gross income going towards your housing costs and other debts. TDS can be no more than 44% of your gross income. As interest rates increase the mortgage payment factored into these calculations goes up, pushing down your maximum mortgage amount.
For this example, I assumed a household income of $80,000, property taxes at $3500/year, no condo fee, and for simplicity, no debt. I also assumed this was an insured mortgage, so a maximum amortization of 25 years, and GDS/TDS ratios of 39%/44%.
Here are the maximum mortgage calculations for a range of interest rates:
4.34% - maximum mortgage $400,900
5.34% - maximum mortgage $363,200 - $37,700 less or a 9.4% drop
6.34% - maximum mortgage $330,700 - $32,500 less or an 8.9% drop
7.34% - maximum mortgage $302,600 - $28,100 less or an 8.5% drop
Rule Of Thumb
Based on this range of interest rates here is a good approximation or rule of thumb:
When rates increase by 1%, buying power drops by 9%.
Its All About The Qualifying Rate, Not Your Interest Rate
When looking at these calculations it is important to remember that the interest rate you actually get is not what is important for your qualifying mortgage amount. The stress test implemented in fall 2016 required lenders to qualify insured mortgages at the Bank of Canada Benchmark Rate, not the rate you actually get. That rate is currently 5.34%. The stress test on conventional mortgages (those with 20% or more down) implemented in January 2018 are even harsher, requiring you to qualify at 2% above the rate you actually get or the Benchmark Rate, whichever is greater.
Get pre-approved today under current rates and guidelines and find out where you stand. If you wait to purchase and rates have increased, you may find you no longer qualify for the purchase price you are targeting. By knowing where you stand you can be ready to jump on a good opportunity as it comes up.
Mortgage Coming Up For Renewal? Most Insured Mortgages Can Switch Without A Stress Test
Is your mortgage renewing this spring? Are you concerned you may not qualify under the new mortgage rules? Then this newsletter is for you.
Two years ago there was a new stress test applied to insured mortgages. This required buyers with less than 20% down payment to qualify based on a mortgage payment calculated at the Bank of Canada Qualifying Rate (aka Benchmark Rate) instead of their contract rate, or the rate they actually get. It effectively dropped buyers maximum mortgage amounts.
But there is a little-known loop hole to the new stress test that could save you a lot of money. I have had several people tell me they are not shopping lenders or rates at renewal because they do not think they will qualify under the new stress test. Lenders know this and many of them (particularly credit unions and big banks) are offering inflated rates to their renewal clients. Dont miss out on the savings you can get from a switch!
Insured Mortgages Best Rates and Stress Test May Not Apply
For an insured mortgage that closed prior to Nov. 30th, 2016, that mortgage can be transferred to another lender qualifying at the 5-year fixed contract rate (ex. 3.69%) they get instead of the tougher stress test rate (5.34% currently). Your mortgage insurance can also travel with your mortgage to the new lender. This means that not only do you qualify under the easier guidelines, but you also have access to todays best rates which are given to those with insured mortgages.
Where This Does Not Apply
Here are situations where this loophole does not apply:
Your mortgage is no longer insured because you have refinanced or changed the structure of the mortgage
You had more than 20% down when you initially purchased
You want a variable rate mortgage or fixed rate shorter than 5-years - these still need to qualify at the higher Benchmark Rate.
Lenders who do not honor this policy - this is where a broker can help!
Call Me and Call Early
More and more lenders are counting on you not to shop your mortgage rate at renewal. Keep more money in your pocket! Call me to confirm what your options are at renewal. And call early you can hold a rate up to 4 months ahead of your maturity/renewal date!
If your renewal is further out and you want to be reminded, just send me a note and Ill set you up with a renewal reminder so you hold a rate early. In an increasing rate environment, being early to hold a rate at renewal can translate into significant savings!
When Should You Start Your Pre-Approval? The Earlier The Better!
If buying a home is a consideration in the next year, it is time to sit down and talk financing. I often sit down with buyers 6-12 months ahead of their planned purchase. If you are selling and buying, it is even more complex and you definitely want to understand your financing options prior to listing your current property. By doing a pre-approval early you get the following benefits:
Find Out If You Qualify
With mortgage rule changes over the past few years, it has become more and more difficult to qualify for a mortgage. It is very important to get a sense of where you stand early in the process and make sure you are prepared. If you do qualify, for what property type and amount? If you do not qualify, what can you do to get yourself to where you want to be? Often there are things that can be done to better position yourself for a purchase. For example, you may need to get access to your equity for down payment or perhaps paying off a credit card or reducing a mortgage payment on another property you own could allow you to qualify.
Learn Mortgage Options Before A Time Crunch
Once you write an offer on a home, you are under a condition deadline to get your financing complete. This can be an intense time and so difficult to make thought-out decisions. Understanding various types of mortgages (ex. fixed vs. variable) and different mortgage features before writing an offer can allow you the time to think through what is the best fit for you. You can avoid a quick decision under time pressures that you may regret later.
Fix Credit Issues
By starting early, you have time to repair credit or even fix errors on your credit report. These can take time to clear up or improve, so it is far better to deal with them before you write an offer and are in a time crunch.
Dont Miss Unexpected Opportunities
If the perfect property or an excellent deal comes up earlier than you expected to purchase, you want to be able to take advantage of the opportunity.
Gather Documents Ahead
Tighter mortgage financing has meant more documents are required by lenders to confirm your mortgage approval. By gathering that paperwork during the pre-approval stage, it makes financing faster when you actually write an offer and have a deadline to meet.
Know How Much Money You Need
Meeting early can give you the time you need to save for not only the required down payment, but also for the additional costs associated with buying a home.
A home is likely the largest purchase you will ever make. By starting your financing early and educating yourself, you will feel more in control of the process and make better, informed decisions along the way. Contact me early for your pre-approval meeting!