Variable-Rate Rulebooks Differ

variable-rate-mortgage-rules RBC has an advantage that other big banks don’t.

Last we heard, RBC is the only Big 6 bank that still uses a 3-year fixed rate to qualify conventional, variable-rate borrowers.

The other five big banks use the higher Bank of Canada 5-year fixed qualifying rate. (This means they calculate your payment based on a 5-year posted rate for debt ratio analysis purposes.)

That’s unfortunate for those five banks because this rule disadvantage is costing them good-quality business. We’ve talked about it with several big brokers. By and large, they’ve moved some variable-rate business away from lenders who qualify conventional mortgages with a 5-year posted rate.

RBC loves it because variable-rate mortgage shoppers with slightly higher debt ratios have no other big bank choices. (Keep in mind, RBC’s risk is mitigated because its applicants are still well-qualified, have 20%+ equity, and 40-42% maximum total debt service ratios).

What does the above difference in rules actually mean in practice?  Well, suppose you make $60,000 a year and have 20% down…

A 3-year fixed qualifying rate of 3.85% means you’ll be approved for a $291,000 variable-rate mortgage.*

A 5-year posted qualifying rate (5.99% currently) means you’ll be approved for only $231,000. That’s 21% less mortgage just because you chose a different bank.

RBC isn’t the only one benefiting from more liberal variable-rate qualification policies. Smaller lenders with similar guidelines are also enjoying a volume boost. Examples include ING Direct, Merix Financial, Street Capital and others. In fact, some would say the new qualification rules are one of the better things to happen to non-bank lenders in quite some time.

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* Assumes no non-mortgage debts, a 35-year amortization, and a conservative lender-imposed 32% gross debt service ratio.

  1. @Vonny Gwan
    The new rules only apply to high-ratio insured mortgages, which are mortgages over 80% loan to value and insured by one of our three default insurers.
    For conventional business, lenders can qualify their deals any way they wish. As the article states, most banks are using the much higher bench mark rate, while others are using what they always have, which have typically been posted 3 year or discounted 3 year rates if the lender is not in the habit of having posted rates like a bank.
    FWIW, First National is currently using the discounted 3 year fixed rate for qualifying conventional variable products.
    John

  2. Banks don’t call clients with 40-42% TDS ratios, well qualified no matter how much equity they have in their home. We call them marginal clients on the forever, ever, ever, debt plan.
    Banks love highly indebted clients since they exploit them for maximum profit and charge higher interest rates since they know full well the client has less options than someone in full control of their finances. It’s smart planning to work a financial buffer/cushion into any households budget. If the only financial cushion a 40%+ TDS ratio client has is to sell their home, that’s no cushion!

  3. Hi Banker,
    Thanks for the note. 40% is the traditional guideline for TDS and many lenders go to 44%. Hence, most consider 40% a reasonable ratio. However, TDS is not the only criteria for being “well qualified.” In the story context above, 40-42% should be considered a maximum. The point was simply that lenders who use traditional VRM qualification rates (like 3-year fixed rates) are still writing quality business.
    Cheers,
    Rob

  4. Robert, your point is correct, informative and well taken.
    Successful Brokers and Salespeople learn to use positive adjectives like “quality” business and “well” qualified to describe a clients business.
    My point is in the Managerial boardrooms of FI’s we generally peel away the salesspeak and quitely speak of the same high debted but qualified clients in less glowing terms.

  5. These days I’m happy when I see an application TDS under 45%. I didn’t know people still had ratios as low as 32/40. LOL

  6. I’m doing a refinance for a radiologist. Good assets, income yada yada yada. He wants to go back to TD but he can’t because his TDS is 45% TDS with them. I’m getting him approved at a non bank lender where his TDS is 36%. Same client but 9 point difference in TDS. It really is a joke that lenders have such different qualifying standards.

  7. @Banker in Ivory Tower> Please correct me if I’m wrong. It seems like you are saying that people with 40% TDS ratios do not “have full control of their finances.” Does that mean they have a significantly higher risk for default? If so, I would love to see statistics to back that up if you have any?

  8. Well, I work a big bank, not RBC & our underwriters will approve a well qualified applicant for conventional mortgage as long as TDS is under 49%…as long as they have some liquid assets, positive networth, extensive credit history …etc !

  9. Hi Big Bank,
    Many thanks for the post.
    So, your bank uses the 5-year posted qualification rate but allows up to a 49% TDS on exception? What is your normal TDS policy? 42%?
    It sounds like this is a case-by-case exception and not a rule?
    Are you comfortable in naming the bank? At a minimum, it would be interesting to know if it’s one of the banks with a broker channel.
    Cheers,
    Rob

  10. That is not what I am saying. As Robert notes, traditional lending theory maintains that a borrowers TDS ratio should not exceed 40-42%. FI’s often exceed such traditional benchmarks but we often demand higher interest rate costs since once such benchmarks are exceeded, among other things, we know the borrowers options to shop their debt is significantly more limited. That is where the control shift I speak of happens.
    As for the contention that the higher the TDS ratio, the higher the defaults, I can only speak from my own experience at FI’s that within the traditional lending framework, I have not seen loan loss provisions account for such a distinction. Hope that helps.

  11. It is also worth noting that TDSR is calculated differently by different lenders.
    As only one example, some lenders will include a “potential monthly payment” on your credit cards, even if you have a zero balance on those cards. Usually this is calculated as a fixed % of your available credit limit.
    Other lenders will only include fixed payments that are actually going out monthly and will not add in “potential” payments.

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