Shut Out From Variable-Rate Mortgages

Declined-Variable-Rate-Mortgage Only 5% of new high-ratio mortgages have had variable rates, versus 15% six months ago.*

People are avoiding variables not just for fear of rising rates, but because many no longer qualify.

This was not to be unexpected (see: The 5-Year Funnel). Up until April 18, a variable-rate mortgage required you to prove you could afford payments based on a 3-year discounted rate (e.g., 3.75%).

Now, the government requires variable-rate applicants to prove they can afford payments at the Big 5 banks’ posted qualifying rate (6.10% today). That makes it distinctly harder to keep your debt ratios within lender limits.

The kicker is that you can’t change lenders at renewal without requalifying. Therefore, if you don’t have 20% equity at maturity you could be stuck in another 5-year fixed mortgage (possibly at your existing lender’s “rack rate”). If you instead want to switch to a variable or 1-4 year fixed term, your debt ratios will have to fit under the much stricter government guidelines at that time.

Of course, those guidelines will get tougher if fixed rates rise.

Today’s 6.10% qualifying rate is 435 basis points above what most borrowers are getting on new variable-rate mortgages. However, in years prior, most lenders considered 150-200 bps a reasonable number.

This is all pertinent because, as experts agree, variable and short-term mortgages are often the best way to keep lender’s hands out of Canadians’ pockets. With many financially stable Canadians now being unable to choose variable/short terms, lenders will get richer and many borrowers will get poorer.

It’s therefore somewhat intriguing that the federal government chose the posted 5-year fixed rate for its new qualifying rate. We heard they were also considering a spread above prime (like prime + 3%).

It makes one curious about the logic that went into the final decision. Is there a real threat of sustained 4.35%+ higher rates?  Or did the powers that be set the bar overly high to herd people into 5-year fixed mortgages—which just happen to be more profitable?

Maybe the latter is just too cynical a thought…

_____________________________________________________

(* Source: Genworth Financial Canada’s Peter Vukanovich, as quoted in the The Gazette; Reporter: Garry Marr)

  1. I think the point is that debt is not a lifetime solution. It’s to be repaid quickly. In the long run, it forces buyers out of the market and reduces the cost of houses, and so enslaves people much less. This takes time though, since prices need to come down for it’s full effect to happen.

  2. Similar to Chris L., I think that if home buyers are all maxing out to the point that they can’t qualify at a couple of percentage points higher, then they shouldn’t be buying that price of house in the first place.
    Almost all of these mortgages will be renewing in 5 years anyway, so the 2% mortgage of 2010 could easily be a 6%+ mortgage in 2015 when renewal comes.
    If people actually intended to stay in their homes more than 5 years, none of this should be a problem — it actually makes sense to qualify at a higher rate.

  3. Hi Chris: Totally agree with your point about paying down debt as quickly as possible. That’s precisely why it’s sad to see so many borrowers (who would have easily qualified 30 days ago) kept from realizing the potential savings of variable rates.
    T.O.: Thanks for the note. As always, it’s vital not to lump all borrowers together. Some borrowers should definitely not be pushing their debt limits. But there are lots of other strong borrowers that could qualify last month, but can no longer get a variable because the new rules push their ratios temporarily and slightly out of line.
    Said borrowers may very well have higher income prospects in the near future (e.g. doctor residents, articling lawyers, new dentists, new accountants, and various other professionals). Or they may have a 2nd source of income or a large cash infusion on the way, with which they can pay down their mortgage.
    The point is, it’s dangerous to impose our wills on all people (and our beliefs on what others should or should not buy) without understanding all the different personal situations and individual repercussions.
    Cheers,
    Rob

  4. Rob, the issue is government intervention then. It is the low rates that have created huge price increases who have turned this crop of buyers into long term debt slaves. I’m not sure if most people realize that lower prices coupled with higher interest rates is better than higher prices coupled with lower interest rates given the same income, but it’s true. I also think we can agree that relative incomes are not and have not risen over the last 8 years where RE doubled in prices in many cases, so the ability to pay off debt is much less with a higher debt and lower relative income.
    Unfortunately, this next set of buyers are the ones to really suffer with high prices and higher mortgages, but then again, who plans to pay mortgages off in under 5 years anyway? So in essence this course of events was seeded from the point a buyer pulled the trigger (based on a low rate). That is, they agreed to both pay a higher price for a house AND pay a higher (normal) interest rate. The whole thing becomes moot when we find our buyers who really planned to own in under five years who really took advantage of lower rates. However, naturally these don’t exist due to higher prices!
    It’s really a giant mess…by the same theory that says mortgages are good because they allow people to buy expensive things they otherwise couldn’t afford. Well if no one could afford them, the prices would be lower and then everyone could afford them!
    Mortgages are good, but not that good. As long as people understand that they are evil, and deserve to be slaughtered, it’s all good in my books.
    I agree with what the government did to fix the mess they created, regardless of the net effect. It sends the message to buyers that debt is bad and should be repaid.

  5. > mortgages “are evil, and deserve to be slaughtered”
    That statement is a little over the top. I don’t like my mortgage either but I’d rather have a mortgage and own my home than rent.

  6. Rob, do you see the government reevaluating the qualifying rate at some point in the future? And for that matter some of the other rules such as the rental offset rules?

  7. Hi Adam,
    Usually when the government makes these rules they stick for a while. Maybe the Finance Department will be thoughtful and revisit the qualifying rate by 2015 when all these 5-year terms come up for renewal. By that time rates may be higher and access to variables should be even more important than it is today.
    As a side note, I think the gov’t was bang on in raising the qualifying rate. No argument there. We’re just suprised they increased it so much.
    As for the rental rules, you’ll probably see more lenders offering 85-90% LTV uninured financing in the next year or so. It may take a while for competititon to bring down their rates though.
    Cheers,
    Rob

  8. Rob, I have expressed some concern for the way the variable qualifying rate is calculated in past comments on your site (which I enthusiastically voted for in the Globe survey by the way).
    By using a de facto average of the Big Five’s posted rates, the central bank is effectively letting the Big Five banks determine the qualifying rate. Since these banks don’t lend at their posted rates, they can increase them to a point where fewer and fewer borrowers can qualify for variable rate mortgages. It costs them absolutely nothing to do this because in the meantime, they can just adjust their discounts to remain competitive in the market. Even better, by pushing an increasing number of borrowers into fixed-rate mortgages, higher posted rates will directly improve each bank’s bottom line.
    None of this should come as a surprise. The banks will always act in their own enlightened self-interest. We just need a better central bank policy for setting the qualifying rate that doesn’t hand the keys over to the Big Five.

  9. okay, so let me see if i understand this… if you try to get a variable rate mortgage, you need to qualify for it at the “qualifying rate”, but if you want a 5 year fixed rate mortgage you only have to qualify for it at the rate that you are being offered? is that correct?
    that would mean that i could qualify for $x mortgage if i go 5 year fixed, but $y if i go variable (x>y).
    if this is the case, then it’s really going to screw over some people. i’m going to be looking to buy around this time next year and i am trying to budget for it as much as possible. i would hate to be forced into a 5 year fixed when i feel variable is the cheapest route. i may have to limit my purchase price in order to save myself some money on the interest and settle for whatever i qualify for under the “qualifying rate”.

  10. Sneeker – you got it. That’s the deal.
    If you go with a 5 yr. fixed you can qualify at the actual rate (about 4.35% today) but if you want variable you have to be able to qualify at a rate of 5.99%. So in reality, at some point you would have to take a smaller mortgage if you wanted to go variable.
    In theory, it prevents a situation like in the US where people go broke when their variable payment starts to rise, so it’s good for long-term market stability. But the way it’s being applied favours the banks (see above) and some feel the current standard being used is too onerous based on current conditions.

  11. What happens to people already with a variable who find themselves up for renewal. Could they be forced into a fixed due to not being able to qualify at the posted 5 yr fixed rate?

  12. You can always stay with your lender at renewal and take the variable rate they spoonfeed you.
    Or you can go somewhere else. If you leave then you have to qualify under the new rules with the new lender.

  13. David,
    Just to correct you slightly.
    The new mortgage rules are not a “central bank policy”. The BoC does not set policy for the mortgage industry or any other industry. The new mortgage rules were put in place by the Department of Finance and administered by CMHC.
    As Rob said earlier, perhaps Finance will review the rules in a few years time.

  14. Let me see. The government invested in mortgages and expects to show a profit this year…
    Hmmm
    “Lender get richer under the new rules”
    wow what is so hard to figure…

  15. You hit the nail on the head. Our trusty government is causing hundreds of thousands of Canadians to pay billions of dollars in extra interest. It is short sighted policy making from big brother designed primarily to get the media off its back.

  16. @Mark. Probably. It is simple economics. More demand for 5 year mortgages means less supply of 5 year mortgage money and higher rates. Banks are just loving these new qualifying rules. Thank you Mr. Flaherty.

  17. Hi David,
    Sorry for somehow missing your post. Many thanks for the support.
    I’m with you on the qualifying rate issue. It is unfortunately a flawed measure. For one thing, the 5-year posted fixed rate is not even linked to the rate it measures borrowers against (a variable rate). A spread above the borrower’s actual variable rate would have been far more logical.
    Furthermore, many argue that the benchmark qualifying rate is simply too high. Is it reasonable to force a variable-rate borrower to qualify for a payment that is 414 basis points above their rate on closing day (based on today’s rates)? What is the probability of prime rate rising to 6.64%+ and remaining there for any extended period? There is surely no such precedent in the modern era of monetary policy.
    Contrast this with current fixed rates. People can qualify for a fixed mortgage today based on a 3.99% rate, versus 5.99% for a variable-rate mortgage. Yet, fixed rate borrowers have to renew in 60 months. What if rates jump from 3.99% today to 6.49% by renewal? How come the Finance department isn’t worried about that? Apparently only variable-rate borrowers are in harms way? We don’t buy that. The powers that be have gone out of their way to favour 5-year fixed terms.
    And of course, there’s the question of our banks being granted power to set the qualifying rate, as opposed to an unrelated party (like the Bank of Canada, or the bond market).
    Prudent policy is vital, but it must be weighed against the cost to homeowners. A large number of people are being forced to throw away interest in fixed-rate mortgages. Imagine what will happen when rates rise a few points. Then, when people really need to be in a variable, the qualifying rate will be over 7%!
    It’s all worthy of further debate at the very least.
    Cheers for now,
    Rob

  18. Hi Rob – While I generally subscribe to the maxim that one should never attribute to malice that which can be blamed on incompetence, this one smells a bit funny.
    As you note, banks effectively set the qualifying rate, and (if I remember correctly from past discussions), banks generally make more off of fixed products than they do off of variables.
    People already tend to reflexively go with fixed terms, regardless of other factors. This just makes things worse, IMO.

  19. Al R – I believe your suspicions are well founded. The Bank lobby got exactly what it wanted. Further to Rob’s point, how sad it will be when prime rate is 5 to 6 pct and only higher net worth homeowners can qualify for a variable rate. Getting stuck in a 4 pct fixed rate is one thing, but getting stuck paying 6.5 pct for five years is quite another.

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