Everything You Need to Know About the Mortgage Stress Test
Applying for mortgage pre-approval or renewing an existing mortgage can be a stressful experience. Since the real estate market changes so quickly and financing conditions are constantly fluctuating, it is important to know if you will be able to repay your mortgage in the event of unforeseen circumstances! This is where the mortgage stress test comes in.
Read this article to learn more about the mortgage stress test and why it is important to pass it. It also discusses key factors to consider and how it affects homebuyers. Let’s go!
What is the mortgage stress test?
The mortgage stress test
demonstrates the ability of a borrower to make their mortgage payments in the
event of a rise in interest rates[1]. If the borrower fails the test, the mortgage is
refused. The exercise is all the more eye-opening in the case of a variable-rate
mortgage.
Federal entities, such
as banks and financial institutions, may require you to pass the stress test
before approving a mortgage, even if you have mortgage insurance[2]. On the other hand, certain credit unions or other
lenders are not subject to this regulation.
How is the stress test calculated?
To assess a borrower’s
repayment capacity, the bank or financial institution uses a qualifying rate.
This refers to the greater of the Bank of Canada reference rate or your
negotiated interest rate plus 2%[3]. This stress test rate (or qualifying rate) is based
on five-year fixed mortgage rates posted by major Canadian banks which are
updated weekly.
At the same time,
lenders use two ratios, namely the gross debt service ratio (GDS) and the total
debt service ratio (TDS)[4] to determine if your borrowing capacity will be able
to cope with a possible adverse scenario.
Who has to take a mortgage stress test?
All new homebuyers must
undergo the stress test. This includes those who put down the minimum down payment as well as those whose down payment is greater than
20%[5].
Moreover, homeowners who already have a mortgage will have to pass the stress test if they want to[6]:
- Refinance a property
- Switch to a new lender
- Take out a home equity
line of credit
However, mortgage
renewals with the same lender are exempt.
How does this affect homebuyers?
By estimating your financial capacity based on a higher rate, the amount of your mortgage will be reduced since the calculation predicts that a good part of your income will be allocated to repaying the debt. It complicates homeownership for first-time homebuyers as they generally have a lower down payment.
In short, the mortgage stress test helps protect you against overindebtedness by allowing you to visualize a worst-case scenario. To find a home that will perfectly meet your needs – and your budget –, team up with a real estate broker who will help guide you in your efforts.
See also:
How to make an offer on a home
School taxes: how much you need to pay
How a good credit score can get you on the property ladder