The Bank of Canada's Big Rate Drop – How does this affect you?

Part One – THE BENCHMARK RATE 

Last week, the Bank of Canada ( BoC) dropped their prime rate to 3.45% from 3.95%, the first rate cut since October 2018. 

Everyone by now has heard that news, but what does this mean to you?

I’m creating a series of posts to explain the various effects of this rate change as I believe that would be appreciated, instead of one, very long post.

The Benchmark rate:

When you are in the market looking for a home and require a new mortgage, or if you are considering a mortgage refinance, the benchmark rate is factored in as part of the approval process.

Since the inception of the “stress test,” borrowers wishing to purchase a home or refinance their mortgage, are required to meet approval guidelines under the stress test.

The stress test is the greater of:

Your actual mortgage interest rate 
or 
The benchmark rate + 200 basis points 

The stress test means that your application must be approved at a higher, qualifying interest rate, even though your actual rate is lower. 

The benchmark rate is used in the stress test and for the past year, the rate has been 5.19%, which is about to change.

At present, the benchmark rate is calculated by using an average of the six major banks’ posted 5-year fixed rate.  These rates are reviewed every Wednesday and an average is used.

As of April 6th 2020, the government announced changes that will affect “insured mortgages” ( less than 20% down payment ) and the benchmark rate will now be calculated based on the country’s median five-year insured mortgage rate plus two percentage points.  As of today, it would be approximately 4.89% says the Department of Finance. It is also expected that “uninsured” mortgages will also have this new benchmark implemented, it hasn’t been officially announced yet. 

With the recent drop in the BoC prime rate, we may see a further rate decrease in the benchmark rate, perhaps even to 4.50%?! This is due to a decrease in both the prime rate and the bond yields, which fixed rates are based on.  With the new benchmark taking an average of the country’s 5-year insured rate average, we are likely to see a further reduction! 

The BoC rate does not directly affect fixed rates, however, due to the economic downturn specifically because of Covid19 and falling oil prices, fixed rates have been dropping.  Fixed rates are tied to the bond yield. We expect these rates to continue to decrease.

If the Benchmark rate is reduced, how will this change affect those looking to purchase or refinance?

The following is a scenario of a home buyer, looking for an insured mortgage ( less than 20% down payment). 

Assumptions: 


Total income: $120,000
Monthly Debt: $200 per month
Property Taxes: $292 per month, $3500 per year 
Heat/hydro: $120 per month
Purchase Price: $650,000
Down Payment: $50,000
Mortgage including insurer premium: $624,000
Actual Interest Rate: 2.34%, 5 year fixed


Chances of Approval:


Under the current benchmark rate of 5.19% – Declined, exceeds debt service ratio maximum ( GDS 39% TDS 44%.)

Under new benchmark as of April 6th, 2020 – 4.89% – Declined, exceeds debt service ratios.

Under new possible benchmark due to rate decrease, 4.50%* – Approved!

The same benefit would apply for those looking to refinance their mortgage, with a reduced benchmark rate it will improve your chances of approval.

*This is an estimate, I do not have any knowledge of the benchmark rate dropping to 4.50%.

We will keep you posted on updates regarding any further changes to the benchmark rate.

I have done my best to break this information down into bite-sized pieces that are easily digestible however, I appreciate that this is information and lingo is part of my daily life and not yours.

Having said that, please do not hesitate to reach out to us with questions, this will affect your buying power!  This will improve your chances of refinancing your mortgage, which you may want to consider just to take advantage of these crazy low rates! Even if you are not looking to purchase or refinance and would just like to understand this better, we are here!

Thank you – Lisa Pellerin, Mortgage Broker, Claystone Mortgage Team Mortgage Architects

Contact your Claystone Mortgage Team agent today

https://claystonemortgageteam.com/ourteam/

Stay tuned for Part 2!