The benchmark rate made headlines in the early part of 2010 when the Government of Canada announced new rules for lending money and qualifying for mortgage loans. These rules were put in place due to perceived volatility in the market, and the government’s desire decrease that amount of volatility.
They introduced the benchmark rate (aka, “qualifying rate”). The benchmark rate is the rate lenders must now use to qualify mortgage borrowers for any high-ratio insured mortgage that does NOT have a fixed term of five years or more. The benchmark rate forces people to qualify at a much higher rate so that it can be proven that, even in the event of a substantial mortgage rate increase, that they are fully capable of handling that mortgage loan.
The purpose of using a qualifying benchmark rate is to ensure that those who qualify for a mortgage in Canada can qualify with breathing room. In the event of a downturn or increase in rates down the road, this prevents Canadians from becoming orphaned homeowners without a lender willing to assist them. In the case of a variable rate mortgage, if the rates start to climb, a maxed out borrower will not be able to afford the payments based on a conversion from variable to a much higher fixed rate mortgage, and may be left with a negative amortization.
For applicants with less than 20% down, a higher qualifying rate typically means a lower maximum mortgage amount. In certain instances, the benchmark rate can be the difference between qualifying for the home you want, or not. It therefore helps to know how the benchmark qualifying rate is calculated.
Here’s how it works – Every Wednesday, the Bank of Canada records the posted 5-year fixed rates from each of the Big 6 banks.
(For a rate change to impact a given week’s calculation, it must be announced before the calculation and have an effective date of that Wednesday or before. Rate changes that are announced Wednesday morning, but don’t take effect until Thursday, are ignored for that week.).
A mode average is taken of the above six rates.
(The “mode” is the value that occurs most frequently. Therefore, one bank’s rate change alone usually won’t affect the benchmark rate.)
The BoC then updates that value on its website. This update is done at roughly 11:30am each Wednesday, give or take “an hour or so,” says Dale Alexander, a BoC spokesperson.
CMHC then uses this value to set the industry-wide benchmark qualifying rate. That is done at 12:01am (Eastern Time) every Monday.
For example, RBC announced its rate change on Tuesday August 3, effective Wednesday Aug 4. All the other banks announced their changes on Wednesday Aug 4, effective Thursday Aug 5. When the BoC calculated the benchmark rate on Wednesday, the mode of the big-6 banks’ 5-year rates was still 4.99%. That’s why the benchmark rate for that week was 4.99%, despite the fact that 5-year posted rates were 4.79%.
Barring no further changes, the new 4.79% benchmark rate will take effect on Monday August 16.
Benchmark rates, in the long run, will help to create stability in the mortgage market in Canada while making sure that there is not a bubble that is created in the meantime. Although mortgage rates in Canada are still very low, it is a mistake to borrow more money than you can comfortably repay, and due to that reasoning the benchmark rate has been introduced to keep the Canadian housing market in check.