5 year fixed mortgage rates have now risen by approximately 1.5% since late 2016. Rising rates mean higher payments, and higher payments mean that you will qualify for a lower mortgage amount. On top of higher rates, everyone now has to pass a ‘stress test’, which lowers your qualified amount further.
The ‘stress test’ means that qualification is based on a higher rate. More specifically, you will need to qualify as if the rate were the higher of the benchmark rate (currently 5.34%), or two percent above the contract rate (the rate your payments are based on). The benchmark rate is set by the bank of Canada and is typically the average of the 5 year fixed posted rates from the big banks.
In other words, if your mortgage rate is 3.79%, then you will have to qualify as if the payments were based on 5.79% since this rate is higher than the 5.34% benchmark rate. However, if you were to choose a variable rate at prime -1.00% (2.95%) for example, then you would qualify based on 5.34%, since it’s higher than two percent above contract rate, which would be 4.95% in this case. If you have a high ratio mortgage, meaning a mortgage that was insured by CMHC, Genworth, or Canada Guaranty (ie, you had less than 20% down when you purchased), then qualification is always based on the benchmark rate.
So what does this mean when your mortgage comes up for renewal?
If you are renewing with your current lender, then no qualification is needed, so worst case scenario is that you renew with your current lender. However, banks do not always offer you the lowest rate at renewal, and in some cases, the offers can be flat out ridiculous. It’s always a good idea to do some research into what other rates are available before signing your renewal documents with your bank. You would think this would be obvious, however many people don’t take the time to see if they are being offered a competitive rate. This is often a costly mistake.
But will you qualify to switch lenders?
Let’s say for example you took out a $500,000 mortgage at a 5 year fixed rate at 2.49% with a 25 year amortization in 2015 and your income was $80,000. You would have qualified for this mortgage at the time, but it would have been tight.
Fast forward five years to 2020. You will now owe $423,104.56, assuming monthly payments and no utilization of pre-payment privileges. You now have 20 years remaining on your mortgage and are now earning $85,000 per year. Using today’s benchmark rate of 5.34%, this borrower will not qualify for a mortgage with another lender as long as he has to pass the stress test. But does he?
Fortunately, there is a bit of a loophole here. Providing you purchased your home prior to November 30th, 2016, which is the case in this example, then there are some lenders who will still qualify you based on contract rate (the rate your payments are based on). This would still allow you to switch to another lender at a lower rate, providing you choose another 5 year fixed term.
Why does it need to be a 5 year fixed?
Because on variable rate mortgages, and on terms shorter than 5 years, a stress test has been required since April 19th, 2010. So if you got your variable rate, or shorter term mortgage after this date, then you had to pass a stress test when you got your mortgage originally. In that case, there is not as much to worry about.
Chances are that rates will be higher in 2020 and could potentially top 6% by the end of that year. Should that happen, you would no longer qualify using the above example, regardless of whether you or not you have to pass the stress test. In this case, then your only option may be to renew with your current lender if you are not earning a higher income at that time.
I can see the stress test being either reduced or flat out removed as rates climb over the next few years. Of course, time will tell as always.
Paul Meredith is the author of the Amazon #1 best selling book, Beat the Bank – How to Win The Mortgage Game in Canada, and has ranked as one of the top 75 mortgage brokers in Canada since 2016. He was a finalist for Mortgage Broker of the Year in 2018, and can be seen as the exclusive mortgage broker on season two of TV’s Top Million Dollar Agent.