MARCH 17, 2011
Understanding the Mortgage Qualifying Rate
I apologize in advance for a short post. I want to highlight a great article over at Move Smartly in which the author nicely explains the Mortgage Qualifying Rate.
Basically, since April of 2010 when Flaherty first tightened mortgage rules, people hoping to take advantage of a much cheaper variable rate mortgage must qualify at a new mortgage qualifying rate (MQR). So while the 5 year variable mortgage at most big banks is currently a ridiculously low 2.25%, the actual amount of mortgage that a borrower is approved for is not calculated using that low figure.
Rather, it is now calculated using the MQR which is essentially the posted 5 year fixed rate at the big banks. As a quick explanation, the posted rate is what is advertised by all banks, though overwhelmingly the actual rate you *should* receive is significantly lower. This is known as the discount rate. If you pay the posted rate, you are a sucker!
The net result of those mortgage rule changes was to make it actually easier to qualify for the 5 year fixed rate. In other words, a new home buyer will now be approved for a larger mortgage if they apply to take out a fixed rate mortgage. Move Smartly actually did a bit of the math:
Let’s use an example to show how the MQR works. Assume that you are applying for a $300,000 mortgage amortized over 25 years, and that the current rates offered are as follows:
Five-year variable rate = 2.25% Five-year fixed rate = 3.99% Mortgage Qualifying Rate (MQR) = 5.44%.
If you want to borrow at the five-year fixed rate, you must pass the lender’s income tests using a monthly payment based on 3.99% (which using the example above is $1,576).
If you want to borrow at the five-year variable rate, you must pass the lender’s income tests using a monthly payment based on 5.44% (which is $1,820) even though your actual monthly payment would be only $1,306 (based on 2.25%).
In other words, if you want a variable-rate mortgage you have to prove to the lender that you can afford for variable rates to rise more than 3% over the next five years. And if you want a fixed-rate mortgage term that is less than five years, the test is the same. You must show that you can qualify using the MQR rate of 5.44%, even though the actual rate you are paying will be lower.
The big question then becomes, why hasn't this had more of an effect on the market? The answer to that is to look at the movement in the yield of the 5 year Government of Canada bond. Movements in fixed mortgage rates track the movement in the 5 year GoC bond yield.
In other words, when bond yields rise, fixed mortgage rates rise also. Variable mortgage rates on the other hand are based on the overnight rate at the Bank of Canada. This is becomes paramount when we look at the movement in yield on the 5 year GoC bond since the April rule changes took effect, we note that yields have generally fallen:
We live in a world where the dual concerns of rising inflation and weakening government balance sheets can raise their heads at any time. We are now overwhelmingly at the mercy of the bond market to sustain house prices at extreme levels of valuation. It's not a good situation to be in. With interest rates facing an inevitable march upwards and with new mortgage rule changes set to further drain the dwindling buyer pool, house prices face significant headwinds moving forward.