Because of the low interest rates on new mortgages, financing a home has never been so attractive. At the same time, less and less Canadians are able to afford mortgages, because of the current volatility in the job market. This situation can be advantageous for investors who are looking for buying opportunities.
Tumbling Interest Rates
On March 27th 2020, the Bank of Canada changed its overnight rate target to 0.25%. This move followed the United States Federal Reserve’s rate cut to near the 0% mark. This policy shift represents a meaningful opportunity to invest in real estate and gain a foothold in a stable and growing market.
Fixed or Variable-Rate Mortgage?
An oft-cited 2001 study by York University finance professor Moshe Milefsky revealed that interest paid on variable-rate mortgages was almost 90% of the time less than fixed-rate mortgages, between 1950 and 2000. Though past performance is not indicative of future results, history is a great teacher. Yet, according to RateHub, almost two thirds of Canadian homeowners prefer fixed-rate mortgages. As an investor, what you need to ask yourself is whether you can handle the risk, and if you would lose sleep over interest-rate fluctuations. If you are able to make changes in your budget according to the market’s mood, variable-rate mortgages will probably help you make long-term savings.
Taking Advantage of Your Bank’s Prime Rate
If you already have a variable rate mortgage, you probably saw a nosedive in your mortgage interest rate, triggered by fluctuations in your bank’s prime rate. Your variable mortgage rate is usually expressed as the financial institution’s prime rate minus a few percentage points. For example, if the bank’s prime rate is 3% and your mortgage is prime rate minus 0.5%, your variable mortgage interest rate will be 2.5%. Currently, Canada’s Big Five Banks (RBC, Scotia Bank, BMO, CIBC & TD) have a prime rate of 2.45%.
If you decide to take on this more risky avenue, you can expect mortgage rates to rise beyond their current levels when the economy bounces back.
Shop Around Before Settling Down
Mortgage brokers can help you compare lending products from different financial institutions. They can search for mortgages with the best deals and get exclusive rates. On the other hand, you can take your time and get pre-approved by a few banks before choosing which one best suits your needs. Aside from offering low interest rates, they can also pay your notary fees or offer cash in exchange for opening a checking account.
Credit Scores and Debt Ratios
Starting on July 1st, the Canadian Mortgage and Housing Corporation (CHMC) will be tightening mortgage rules to obtain an insured mortgage.
Whether you have a 5% or 20% down payment on your home, your financial institution still needs to know if you can afford making the payments for years to come. Because of the current volatile economic circumstances, it’s understandable that some cooling measures are implemented along with lower interest rates.
Three main indicators can help determine how much room you have for additional debt: your Gross Debt Service (GDS) Ratio, your Total Debt Service (TDS) and your credit score.
Gross Debt Service
Your gross debt ratio can be calculated by dividing your projected monthly home related expenses by your monthly earnings.
Principal + Interest + Taxes + Heat
Gross Annual Income
Total Debt Service Ratio Formula:
Principal + Interest + Taxes + Heat + Other Debt Obligations
Gross Annual Income
If you are purchasing a new home, it will be hard to estimate the taxes and heat without a history of payments over the years, but you can still calculate your mortgage payments.
Your principal and interest payments can be determined using CMHC’s mortgage calculator, and will vary according to your mortgage principal, amortization, payment frequency and interest rate. If you’re thinking of making annual prepayments, that can also accelerate your payments and help you avoid interest on the long run.
Taxes and heat depend on a large array of factors. These figures can be approximate, as a new construction won’t have any previous electricity bills, and the City of Montréal doesn’t provide property tax estimates for future homes. If you know someone who owns a condo with a similar value to the one you are purchasing, you can ask them about their tax and hydro bills.
Once your total debt service is calculated, the number should sit comfortably around 30%. If it’s higher than that, it may be more challenging to take on a new mortgage. In that case, you may have to increase your down payment or get rid of some of your credit card debt, before taking on a new mortgage.
If you need help figuring out what kind of mortgage is best suited for your needs, we can put you in touch with one of our trusted mortgage brokers.