The Learning Centre:
Taking the mystery (and the stress) out of the mortgage stress test
(Reading time: 3:30)
On their own, the words ‘stress’ and ‘test’ don’t exactly say, “well, this is going to be fun.” Put them together; then add the word ‘mortgage’ into the mix… now you’ve got a process that has been causing Canadian home buyers trepidation and confusion.
With 43% of Canadians not fully understanding how the mortgage stress test works, it’s time to take the mystery and the stress out of ‘the test’.
To demystify the whole stress test process, we enlisted the expertise of our very own Lending Services team.
One of the most common questions Educators Agent-Mortgage Specialist Federica Screnci gets from clients is, “What exactly is the mortgage stress test?”
“To put it simply, the mortgage stress test is a tool used by lenders to ensure that borrowers will still be able to make payments on borrowed funds in the event interest rates rise,” says Federica.
But how exactly does the mortgage stress test work?
Federica continues, “Let’s say you want to get approved for a mortgage. Using the stress test, lenders will consider two factors in order to qualify you—the mortgage rate being offered plus 2%; along with the current 5-year Bank of Canada benchmark rate. Whichever of the two is greater is the rate you’ll have to qualify for. Think of it as a safety buffer the lender is putting in place in order to gauge your ability to continue meeting your mortgage payment obligations, should interest rates continue to climb.”
Educators Agent-Regional Director Chris Knoch elaborates on Federica’s explanation with an example.
“This means if you are applying for a mortgage at a rate of 3.5%, your lender will assess you as if you were paying your home loan at 5.5% (3.5% + 2%). Since 5.5% is greater than the Bank of Canada’s five-year benchmark rate (which is currently 5.34%), your current financial situation would have to show that you would still be able to make mortgage payments at a rate of 5.5%.”
What is a ‘benchmark rate’? A qualifying rate set by the Bank of Canada that is comprised of an average of the current posted 5-year fixed rates offered by Canada’s 6 major banks.
How much of a difference can that extra 2% make on the amount of mortgage you qualify for?
That depends on the amount of mortgage you’re looking for. Educators Agent-Mortgage Specialist Mara Rossi paints a picture of the potential impact.
“I was reading a study the other day stating how the majority of Canadians (59%!) still don’t realize how the mortgage stress test could impact their buying power. That’s a lot of people who could be aspiring for a mortgage that is beyond their reach.”
Mara goes on to do the math:
(with stress test in play)
|Qualifying rate (example)||3.5%||5.5% (3.5% + 2%)|
|Qualifying mortgage amount
(Example based on income of $4,000/month)
|Impact on borrowing power||—||– $40,000|
“To give you an idea of the difference that extra 2% stress test ‘buffer’ makes, let’s say you’re in the first few years of your education career and earning roughly $4,000 a month. Using Chris’ 3.5% interest rate example, prior to the stress test you would qualify for a mortgage of about $230,000 (assuming you had good credit and the term was amortized over 25 years). With the stress test now in play and increasing the qualifying rate to 5.5% (3.5% offered rate + 2% stress test buffer), you would now qualify for a mortgage of $190,000. That reduces your borrowing power by $40,000.”
Is there any way of getting out of taking the mortgage stress test?
Possibly. If you currently have a mortgage and are looking to renew with the same lender, the stress test may not be required. Also, lenders that are provincially regulated aren’t required to enforce the stress test (although some may choose to do so). Note that if your mortgage is up for renewal at one of the big banks (which are federally regulated) and you decide to switch to another similar-type lender, the stress test would then indeed come into play.
Other instances where the stress test is mandatory:
- When refinancing your home
- When you are taking equity out
Facing no other option but to take the mortgage stress test? No problem. Federica, Chris, and Mara have put together some pre-planning tips to take the ‘stress’ out of the test.
- Keep your debt-to-income ratio under control.
- Pay down your debt as much as possible prior to applying for a mortgage.
- Use a mortgage calculator to see what kind of mortgage payment you can realistically afford
- Look for ways to cut spending to maximize your monthly cash flow
- Develop a down payment-saving strategy
Let our lending specialists take the stress out of your mortgage application process.
Whether you’re shopping around for your first mortgage, or are looking to renew/refinance your existing one—reach out to Educators Financial Group. Because no matter where you are on the pay grid or what your pension income is in retirement, we can offer you a stress-free mortgage solution that fits your specific financial situation and provides you with peace of mind.
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The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.