Today is the day, the Government of Canada has raised the bar that anyone must meet when applying for a mortgage. You’re probably wondering, how does this affect me or what is the stress test anyways?
In 2017, the federal government introduced a mortgage stress test for anyone who is applying for a mortgage or renewing a mortgage. They have now changed this again and it is taking effect today. So, what does that mean for me? Well, you’re not alone – many Canadians are still confused about what it is and how it will affect them. We will start by saying that the stress test applies to everyone. Whether you have amazing credit and a 20% down payment, you will still have to go through the stress test. In other words, if you have a mortgage or plan on getting one you will have to go through the stress test.
What is the stress test?
Let us start by saying that it’s not actually a test, rather it is a set of rules or qualifiers that banks and lenders must now use to determine if you qualify for a mortgage and how much you can qualify for.
Why was the stress test created?
The stress test was first created in 2017 to protect borrowers, like yourself. Because interest rates have been at historic lows that can and likely will eventually go up, the government wants to make sure that if they do so you will still be able to afford your mortgage payments.
How does the stress test work?
As of June 1, 20201 when you apply for a mortgage the bank will offer you an interest rate based on your credit score. The higher the credit rating, the better the interest rate. However, under the stress test, that is not the rate that the lender will determine your mortgage eligibility. It will make the calculations based on a higher interest rate to ensure that you will be able to make your payments if the rate increases.
So, the minimum qualifying rate for both uninsured (with at least 20% down) and insured (less than 20% down), mortgages will be higher of the following:
- The rate offered by your lender plus 2%; or
- 5.25% (up from 4.79% prior to June 1)
Now the fun part, let’s put this into real terms that would give you a scenario. If you wanted to borrow $400,000 and your lender is offering you a rate of 1.78%, you would have to prove you can afford a mortgage payment of about $2,385 per month (at 5.25%), even though your actual mortgage payment at 1.78% would be lower at about $1,650.
What does the stress test mean for borrowers?
As a first-time home buyer, it makes it a lot more challenging for you to get into the market.
For example, if there were no stress test at all, with a hypothetical household income of $112,500 and debt levels within the 40% total debt service ratio threshold, could qualify for a mortgage of $577,500 assuming a five-year fixed rate of 1.78%- and 25-year amortization period. Now, with the stress test the maximum mortgage decreases to $400,000.
There is no doubt that this is a huge difference as a first-time home buyer, especially in a hot market like we are seeing now. If you are renewing your mortgage, you will need to pass the stress test only if you switch lenders. However, you cannot really shop around for a better rate or negotiate when renewing so it affects them differently.
You might be wondering, is there any way to get around the stress test? The answer is simple, not really. All major lenders are required to enforce these rules. However, credit unions and other lenders enforce them voluntarily to reduce their risk exposure.
If you are a first-time home buyer, it is now more important than ever to save up as much as possible, pay down any other debt and if possible, get a co-signer. This will all help you qualify for a larger mortgage.
If you have any questions about how the mortgage stress test will affect you or would like to talk to someone about how you can put yourself in a better position when purchasing a home, you can contact us and we will be happy to help! We know this is a challenging time for those who are entering the market and we want to help as much as possible. We are here to help and answer any of your questions – and the best part is there is no fee to you!