Did you know it’s typically harder to qualify for a five year variable rate mortgage (VRM) than it is for a five year fixed rate mortgage? Even though the rates are lower. It’s also true that most fixed term mortgages less than five years are just as hard to qualify for. There are a few lenders whose underwriting guidelines are more forgiving, but they are the exception rather than the rule.
Why is this so? The reason is mortgage lenders worry about your ability to make your payments if interest rates go up over the next several years. So they do a “Let’s Pretend” exercise.
When evaluating a VRM application, they pretend the interest rate on your new mortgage is actually 4.79%. This is called the “Qualification Rate”, and it is set weekly by The Bank of Canada. Regardless, don’t worry; your actual payment will be set at the contracted interest rate.
Here’s the logic:
If you wish to have a VRM, your interest rate may increase over the five year term. This can happen for one of two reasons:
- If you choose to convert to a fixed rate mortgage at some point, or
- If the Bank Prime rate increases, as this would automatically increase the interest rate on your VRM
Similarly, if you choose a fixed rate mortgage with less than a five year term, (example 2 years at 2.34%) your lender is concerned about your rate at renewal. So again, they check out your ability to qualify at a rate of 4.79%.
But once you choose say a five year (or longer) fixed rate mortgage at 2.89%, this is the rate you are qualified on – NOT the Bank of Canada Qualification Rate. Let’s see the impact of the Qualification Rate on a $300,000 mortgage with a twenty five year amortization period:
|Selected Mortgage||Actual Contracted Payment||“Qualifying Rate” Payment|
|Variable Rate 5 years at 2.35%||$1,338.11||$1,730.49|
|Fixed Rate 3 years at 2.69%||$1,389.61||$1,730.49|
|Fixed Rate 5 years at 2.89%||$1,420.39||$1,420.39|
As you can see, the VRM will have the lowest monthly payment, but is much harder to qualify for than the five year fixed rate mortgage. The reason is lenders like to assess your ability to repay the mortgage by calculating your “debt service ratios”. The higher your imputed mortgage payment, the higher your debt servicing ratios, and the less mortgage amount you will qualify for.
On the bright side, some lenders may not do this if the loan to value ratio is at 80% or less. Of course, the Qualification Rate is just one of several important factors to consider when choosing your mortgage. Best you find a mortgage specialist you can trust to help navigate through all the bells and whistles which come with your mortgage – there are hundreds of permutations, why not have an experienced expert help you at no cost to you?
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