New mortgage stress test rate | What this means for you
You may have heard that Canada's mortgage stress test rates are increasing as of June 1st, 2021 - If you're like most Canadians, you may be thinking "what does this mean?" or "how does this affect me?"
First of all, we need to realize that the 'new rates' are what matters and the 'old rates' are irrelevant. Let's face it, the mortgage stress test is not going away any time soon. It is just evolving to adapt to the current market conditions. Lenders are still approving based on the same criteria - employment and income, debt, credit history and the property itself - just with an extra twist.
What is a mortgage stress test?
Stemming from the finance world, the term “stress test” is a test used to determine a worst-case scenario when making an investment. When applying this to mortgages, it’s a method of determining how much you can afford; and under what circumstances. Banks are now required to apply this set of stringent rules to all new applications.
What is it for?
The mortgage stress test rules exist to protect borrowers. Interest rates have been at all-time lows and are only bound to rise. The government has issued this test to ensure borrowers will still be able to afford their mortgage payments when rates undoubtedly increase. What they are trying to avoid is having borrowers overextended and unable to afford higher payments in the future.
How does it work?
When you apply for a mortgage loan, the bank will offer a current interest rate available under your specific circumstances. They will use this interest rate alongside your income and employment, credit history and debt ratios to calculate an pre-approval purchase amount. Here comes the twist - they will then increase the interest rate to meet stress test requirements and then run the numbers again. The outcome will be a lower approval threshold.
What rate will the lender use?
As of June 1st, 2021, the minimum qualifying rate for both uninsured mortgages (those with at least 20% down payment) and insured mortgages (those with less than a 20% down payment) will be the higher of these options:
The interest rate offered by your bank/lender plus 2%; or
What does this look like?
Here is a mortgage loan example to put this into a more ‘real-life’ perspective:
Borrowed amount: $400,000
Lender’s offered interest rate: 1.78%
Actual monthly mortgage payment: $1,650
Stress test interest rate: 5.25%
Stress test monthly mortgage payment: $2,385
In this scenario, in order to qualify for the borrowed amount the purchaser's income and debt ratios must satisfy the affordability of a $2,385 per month payment when in all reality they would only be paying $1,650 per month.
Is there a way to avoid the mortgage stress test?
The short answer is “not really.” In Canada, the big banks are forced to abide by these rules, so unless you are using a private lender the stress test is now a way of life.
There are however things potential borrowers can do to try to increase their home affordability. Obviously, saving more for a down payment is a no-brainer but often easier said than done especially with skyrocketing rent prices. Having a co-signer on your mortgage application can also assist in a higher mortgage approval.
Does this test affect mortgage renewals?
Renewing mortgage holders are not required to “pass” the stress test unless they switch lenders or are planning to refinance. However, they are still affected in that they are unable to shop around for a better rate or even negotiate the terms of their existing mortgage loan without risking undergoing the stress test rates.
At the end of the day, if you are a first-time homebuyer trying to get into the housing market, the stress test is going to make it a lot more difficult. With the hot real estate market, limited supply, and a significant year-over-year increase in prices, obtaining a new mortgage even with great credit and high income is challenging.
That being said, the stress test is intended to protect us from overextending ourselves and borrowing to the absolute max without any wiggle room. As annoying as this may be currently, you may be thankful for it should interest rates skyrocket in the future.
Still have questions?
Reach out and I'd be happy to answer any of your questions or concerns or set you up with a great mortgage specialist to help you navigate these new rules.