The best mortgage strategies in a rising interest rate environment

With rates rising, buyers and homeowners need to carefully consider what their best mortgage options might be.valentinrussanov

Eitan Pinsky and his wife were still settling into their newly purchased $4 million home when the Bank of Canada raised its benchmark interest rate by one percentage point to 2.5% at the mid-July.

For the Vancouver couple – who are among the roughly 53% of Canadian homeowners with variable rate mortgages – this meant an increase in the interest rate on their home loan.

“So we ended up increasing our payments a few days ago because if we didn’t, our amortization period would be longer,” says Pinsky, owner of Pinsky Mortgages, a Vancouver mortgage broker. “Now many clients ask us: what should they do with their loan? »

This is the burning question today for Canadians looking to buy a home or refinance their mortgage. Until recently, it made financial sense for many homeowners and buyers to choose an adjustable rate mortgage. But with the gap between variable and fixed rates narrowing, many are starting to take an interest in the latter – a development that even inspired Canadian food franchise Pizza Pizza to offer a “fixed rate pizza” offer. which allows customers to lock in the price of an extra-large four-topping pizza for up to a year.

“The big decision people face today is, ‘Should I lock myself in?’ “, says Ross Taylor, mortgage broker and owner of Ross Taylor Mortgages in Toronto. “But I think the most important question people should ask themselves is, ‘What is the best mortgage for my particular situation and my risk tolerance?

Affordability is a factor directly affected by rising interest rates. A buyer who would previously have qualified for a $500,000 mortgage under the federally mandated stress test – which assesses buyers’ ability to afford a mortgage at the Bank of Canada’s posted rate on five years or their contract rate plus two percent, whichever is greater – can now be approved for about $50,000 less.

Since interest on variable rate mortgages is always lower than fixed rates, today’s buyers will qualify for a higher loan amount if they become variable. But that’s not good for risk-averse borrowers.

Mr. Taylor offers a solution: take out a variable rate mortgage, then switch to a fixed mortgage after the deal closes.

“It’s a little workaround,” he says. “You can switch from a variable rate to a fixed rate with the same lender without having to requalify.”

Getting a mortgage from a credit union can be another way to qualify for a larger loan amount despite higher interest rates. Allison Van Rooijen, vice president of consumer credit at Meridian Credit Union, points out that credit unions are regulated at the provincial level and are not bound by federal stress testing rules.

This allows some wiggle room for qualifying mortgage applicants.

“Many credit unions have flexible options that can be offered to borrowers outside of the traditional stress test,” says Van Rooijen. “A debt-service ratio shouldn’t make or break a mortgage decision in isolation from other factors.”

Whether they are dealing with a credit union or another type of financial institution, borrowers should confirm whether they have received actual pre-approval for a mortgage or just conditional approval.

With a pre-approval, the lender owns the rate and commits to the transaction. A conditional approval, on the other hand, gives borrowers a general idea of ​​what they can afford, but is not an actual commitment on the part of the lender.

“Borrowers need to understand this before they start looking for what they think they can afford,” says Van Rooijen, who notes that what homebuyers can afford these days may also change when they sell a home that closes below price. they expected to get.

So, if interest rates also continue to evolve, should borrowers who currently favor variable rates rethink their choice of mortgage loan?

For those who want to hedge against further rate hikes but don’t want to make a long-term commitment to a fixed-rate mortgage, Van Rooijen suggests taking a look at a shorter-term loan.

“We’re seeing very favorable rates right now in the space of two to three years, but borrowers need to figure out where they see themselves when that term comes up,” she says. “Also keep in mind that if rates continue to remain high enough, you will renew at the market rate at that time.”

James Laird, co-CEO of loan comparison website, says historical data indicates variable rate mortgages are “the lowest cost solution, almost every time.” At the same time, the availability of fixed payment solutions allows borrowers to maintain the same regular payments – unless rates reach a point where payments are no longer sufficient to cover the loan principal amount and the cost of the loan – but with a smaller portion of the payments going towards the principal.

“So even if your payments don’t change, what does change is the duration of your payments – it lasts longer,” says Laird. “Some people see this as a middle ground because they get a fixed payment, at least for the current term.”

By comparison, homeowners who purchased their home with a variable rate mortgage would have seen their payments increase when the prime rate increased in July. However, their principal payments – and amortization period – would have remained constant.

Pinsky of Pinsky Mortgages cites two ways variable rate mortgage holders can meet their amortization schedule: increase the regular payment amount or make a lump sum payment.

“With many of our clients, we suggest offering a lump sum of up to 15%, which most lenders allow you to do as many times as you want, while some only allow one only once a year,” he says. “Many choose to go this route rather than increasing their payments because with a lot of lenders once you go up [with regular payments] you can’t go back down.

While rising rates have made it more important than ever for homeowners and buyers to choose a mortgage they can comfortably carry, now is also the time to develop a budget and financial plan that takes into account the possibility more increases in the near future. , says Mr. Pinsky.

“Put some money aside or, if you can, get a home equity line of credit as a safety net,” he says. “And if you get a line of credit, only use it if absolutely necessary.”

Mrs Van Rooijen agrees. In recent years, borrowers have tended to focus more on their debt repayment plan and not enough on budgeting and saving, she says. That’s not going to cut it with today’s higher rates.

“I would challenge borrowers to make sure, when considering mortgage solutions, that they consider all of their day-to-day expenses – like food and gas – in addition to larger expenses like maintenance and taxes,” she said. “Now more than ever, they need to have a coordinated debt and savings strategy that, among other things, ensures cash flow in case of an emergency – or in case rates go up.”

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