The interest rate on your mortgage is a significant variable in the home-buying process. A seemingly small difference in mortgage rates can add up to thousands of dollars over a 5-year term.
Naturally, this leads many potential homeowners to choose rate-hunting as the first step to purchasing a home and acquiring a mortgage. You may see a reasonable rate advertised, set a housing budget and even start housing hunting with the assumption that you’ll get that rate – but that’s not a good idea, and here’s why.
Why your mortgage rate isn’t the best place to start:
Reason #1 – it’s misleading
Rates advertised online are often the best available rate, available only to a particular type of client. Typically you’ll need to put down less than 20% and pay for mortgage default insurance to get the rock bottom rates. Why? Because lenders set the rate based on the level of risk. If CMHC insures your mortgage, there’s essentially no risk for the lender. You could assume you’ll get that rate, but that particular rate might not be available to you. You’ll want to figure this out early; before you put an offer on the home.
This is a good time to mention that the rate you get is not the rate they will use to evaluate how much you can borrow. As of January 2018, anyone who applies for a mortgage at a federally regulated lender must undergo a stress test, wherein affordability is based on the qualifying rate. The greater of your contract rate + 2%, or 5.25% (as of June 1, 2021).
Example 1: Your contract rate is 2%, so you’ll qualify at 5.25%.
Example 2: Your contract rate is 4%, so you’ll qualify at 6%.
You may think it’s fine to grab the lowest mortgage rate you find online and start your budgeting from there. But in the end, you’re far better off using a hypothetically high number to help determine what kind of mortgage you can afford. This will help ensure you pass the stress test, and it will give you some wiggle room to accommodate unexpected costs.
So searching for an interest rate as a first step toward homeownership can not only set you up for a surprise down the road, but it can delay the entire process of acquiring the home you want, if it leads you to be turned down by your lender.
Reason #2 – it’s inefficient
Yeah, the rate on your mortgage is important. But a single-minded focus on the interest rate is sort of like buying a car where you only look at the price. In this analogy, if you plan on hauling dirt, would it make sense to buy a 4-door sedan because it’s cheaper? Rate is only one feature of the loan agreement. You may be able to find a great rate, but you may not be able to use it because it’s with a lender who won’t offer you other features that you need or who won’t work with you at all because of a perceived risk factor (such as a job change or short credit history). At that point, you’d have to start your rate hunt back at square one.
Also, let’s not forget there are many types of mortgages, and they’ll have different rates attached to them.
Another trap that homebuyers fall into is wasting time looking for good rates when they simply don’t have access. If you ask your mortgage broker to do the searching on your behalf, not only can they search for the right type of lender and the right type of mortgage, but they have access to wholesale rates and other information that individual buyers simply won’t see. They’ll also help you negotiate down from the rates advertised by lenders.
Finally, rate hunting can be an inefficient first step because there’s no context to your search. What rate will be too high for you to afford? What’s your timeline and how long will that rate hold? What type of institutions are likely to approve you? There are too many questions remaining, and your time will be better spent answering them.
If you’re looking at rates too early, you could be putting the cart before the horse – so when is the right time?
The right time to start looking at rates
It never hurts to have a general idea of where rates are sitting, but a serious comparison of rates comes later in the process.
Without getting into a full overview of the steps to getting a mortgage, start by getting an understanding of where you stand financially with respect to buying a home. Take a look at how much cash you have available to use as a down payment, get your free credit report from Equifax or TransUnion, and take a look at your debt ratios (see our article on this topic) to help evaluate affordability.
This should help you paint a picture of what kind of home you may be able to afford and what kind of mortgage you may be approved for. Showing this picture to a lender is typically enough for them to give you a ballpark estimate mortgage rate. Showing this picture to a mortgage broker will be enough for them to explore and compare a huge range of rates, lenders and mortgage options – not to mention help you decide what type of loan may be best for you, which lenders will suit your needs, and what your next steps are.
If you’d prefer to go a step further, you can provide your lender or broker the documentation they need to gain a mortgage pre-approval. While this does not guarantee a future mortgage approval when you do find the home you want, the rate shown in your pre-approval will typically hold for 120 days. That gives you about four months to set some clear house-hunting parameters and search for your dream home.
No matter what your goals, questions or concerns, the best place to start is a conversation. Before you begin searching for rates, reach out to us to get a better idea of where you stand and what you need to do to get yourself in a position to negotiate the best rate possible.