Variable Rate Mortgages have become overly popular lately as borrowers are eager to take advantage of the low Prime rate. When applying for a mortgage, we do our best to help our clients make find the lowest rates and most suitable mortgage products. However, often after our initial consultation, some of our borrowers are surprised to hear that they don’t qualify for a five-year Variable-Rate Mortgage (VRM) and have no choice but to take the five-year Fixed-Rate Mortgage (FRM) instead. After all, if the VRM is lower, why should qualifying for it be more difficult?
When qualifying for a mortgage, the lenders/insurers determine whether or not you can afford the loan amount you have requested based on a number of factors. These include, but are not limited to, your annual income, monthly heating costs, property taxes, strata fees (if applicable) and the maximum mortgage payment you can afford each month, based on your chosen mortgage rate and amortization period.
Currently, the industry standard allows for a maximum of 35 to 39% (depending upon credit scores) of the annual borrowers income to be allocated towards annual mortgage payment, heat, property tax, and strata fees. For example if a John earns $50,000 on an annual salary, we can use 39% of his income ($19,500) towards his annual housing costs. Let’s say property taxes are $2,000 per year, strata fees are $2,400 per year, and heating costs are $900 per year, he would be left with $14,200 for maximum annual mortgage payments – making it a maximum of $1,183 per month.
If you wish to pursue a VRM, you have to prove to the lender that you can afford for variable rates to increase more than 4.64% over the next five years and afford future mortgage payments by using the ‘Qualifying Rate’. The Qualifying Rate was legislated by the Canadian government and requires you to qualify for a five-year fixed mortgage to ease affordability concerns with lesser mortgage terms and variable rates. Right now, the Qualifying Rate, set by the Bank of Canada is at 4.64% and closely resembles the average posted five-year fixed rates from most Canadian lenders. The five-year fixed discounted rate is currently at 2.69%, this is the rate that most borrowers qualify for when obtaining a FRM.
The Canadian government introduced a policy in recent years to make sure that if the Prime rate increased from currently 2.70% to for example 5%, then borrowers could still afford to make their mortgage payments. The policy requires most lenders and insurers to qualify the borrower under the Bank of Canada Benchmark rate for any mortgage/line of credit that is either a VRM or any fixed term of less than five years. Going back to the example above with John, at $1,183 per month, he would qualify for a mortgage of $210,700 if he applied for the Variable Rate vs. $258,000 if he was to apply for the five-year fixed rate, a difference of almost $48,000 in mortgage money. If you are looking to qualify for a higher mortgage amount, you will likely need to opt for the five-year FRM.
