Interest rates are currently at historical lows, but we know that can't last forever. With interest rates and qualifying rates so low, homeowners are experiencing more affordability and purchasing power.
But what will happen when your variable rate mortgage rate increases?
To gauge a borrower's ability to handle the possibility of rising interest rates with a variable rate mortgage we use a handy acronym called IDEAS.
IDEAS stands for Income, Debt, Equity, Assets, Sensitivity to Risk.
- Income-- Is the borrower's income stable and reliable?
- Is there a low chance of income interruption? (You don't want payments to soar if there's a chance you'll be out of a job for a while)
- Does the borrower earn enough to pay his/her variable-rate mortgage as if it were a 5-year fixed mortgage? (i.e., Can he/she afford to set his/her payments higher to offset the effect of rising rates?)
- Debt-- Does the client have a reasonable debt ratio?
- Is the person's total debt ratio under 44% based on the posted 5-year fixed qualification rate (so that his/her budget isn't crushed if prime rate jumps to 6.25% or more)?
- Can the borrower withstand 50% higher payments if rates rocketed up 6%?
- Equity-- Does the client have enough equity?
- Is the loan-to-value under 80-85% so the person could refinance if absolutely needed?
- Assets-- Does the client have enough assets?
- Preferably 6 months of living expenses (in liquid assets) to act as a payment buffer if needed.
- Does the person have a credit line as a backup source of liquidity?
- Sensitivity (to Risk)-- Can the client accept risk?
- If rates increase 2.50%, can he/she handle payments rising over 30%? What if rates jump 6%?
- If most, or all, of the answers to the above are affirmative, a variable rate is something that you can entertain.