How a Mortgage Pre-Approval Can Protect You from Rising Rates
Over the past month, we have seen several fixed mortgage rate hikes from the banks and other lenders.
We all suspected rates would rise eventually, but this is happening much sooner than expected.
Do rising interest rates affect mortgage pre-approvals?
Rising interest rates make mortgage pre-approvals much more relevant and meaningful.
Not only does a mortgage pre-approval give you the lender’s estimate of your borrowing power, but it also offers you an interest rate hold for up to 120 days in many cases. In times of steady or declining rates, you barely pay attention to your pre-approval rate. But these days, this rate hold can be a total game-changer.
If you are pre-approved for a fixed-rate mortgage, you may find yourself in a very fortunate situation when rates increase, because as long as your mortgage funds while your pre-approval is valid, your mortgage lender should honour your pre-approval rate.
This past week, we had clients who completed their home purchase with a pre-approved 5-year fixed rate that simply does not exist anymore for uninsured mortgages.
Is it worth getting a mortgage pre-approval for a variable-rate mortgage?
Yes, it absolutely is worthwhile. The rate for a variable-rate mortgage is expressed as a discount to the lender’s prime rate – and that discount is what could change during your pre-approval period.
Your variable rate is expressed as a discount from prime rate, which is influenced by the Bank of Canada’s overnight target rate.
Your pre-approval will lock in today’s discount regardless of changes to the prime rate itself.
But if you recall, in 2020 we saw a sudden and profound change to the discount for variable-rate mortgages in the early days of the pandemic. The discounts actually disappeared, and if you wanted a new variable-rate mortgage it would have been at the prime rate, or even higher.
Fortunately, this didn’t last too long. In time, order was restored to the markets, and so were the variable-rate discounts. But this experience proved it is also good to pre-approve a variable-rate mortgage.
Do some variable-rate mortgages offer fixed payments?
If you are pre-approved for a variable-rate mortgage, in most cases your payment will be immediately affected by changes to the prime rate. But some lenders offer variable-rate mortgages where the payment remains constant throughout the term of the mortgage.
That can cushion the blow to your monthly cash flow, at least until your renewal date. In this scenario—where the payment remains the same—if rates rise, more money will go towards interest and less towards the principal. The opposite is true, of course, when rates fall.
This sort of variable-rate mortgage is quite compelling these days. Being able to lock in your mortgage payment at a lower variable rate compared to a higher fixed-rate alternative is appealing to home buyers and refinancing homeowners who are cash flow-conscious, above all else.
What are the benefits of a mortgage pre-approval?
You have protection—or insurance—against higher rates during your pre-approval period (for many lenders, this can be up to 120 days). Let everyone else pay more than you, because your rate hold gave you every advantage with no disadvantages. If rates had fallen instead, you would still be a free agent and could benefit from those lower rates. So, with a pre-approval you can have your cake and eat it too.
You know your borrowing power. This is so essential when buying a home, in particular. One of the worst things you can do is fall in love with a home that is not within your budget. But if you do find yourself in that situation, you must consider other means to solve the problem. For example, you can source a bigger down payment or ask a family member to co-sign your mortgage application. There are numerous occasions when working with a co-signer on your mortgage is beneficial.
In some cases, when you are pre-approved your credit has been checked and your application and documents have been reviewed. Note that this isn’t always the case, so be sure to ask your broker or lender. When you are house-shopping and find a property that you wish to make an offer on, you can ask your mortgage broker if the math works for that specific property. While this still isn’t a guarantee that you’ll be approved for the mortgage, the numbers can be run quickly in cases where you’ve submitted supporting documents and had a credit check as part of the pre-approval process.
Many brokers and bankers do not go out of their way to offer mortgage pre-approvals. They feel it can be a waste of their time. After all, generally only a minority of pre-approved mortgages actually fund with the lender who pre-approved them, although that percentage increases in times of rising rates when many pre-approved rates are no longer available on the market. Additionally, a pre-approval often adds a slight premium to the rate.
But, in my view, this is short-sighted. A mortgage pre-approval is totally worth the effort. We owe our home-buying clients a mortgage pre-approval whenever possible. You can expect more people will jump on this bandwagon now that rates have started to climb higher.