No one likes to hear the word “test”. But don’t sweat, this is a test you don’t have to study for. A mortgage stress test isn’t exactly what it seems. Sure, it can still send chills up your spine and you may lose some sleep wondering if you’ll pass, but with an experienced mortgage broker by your side, you can attain a happy and healthy mortgage for your dream home.
As a financial advisor and an expert at securing mortgages for all kinds of people, I can guide you through the process and offer you solutions for getting the approval you’re looking for.
First, what is a stress test?
A stress test is a calculation based on how much money you earn to determine the amount of mortgage loan you can afford. It helps determine whether or not you will still be able to afford and make your mortgage payments on time if mortgage rates increase significantly.
How does a stress test work?
Anyone who applies for a mortgage at a federally-regulated financial institution, even if they have a down payment of 20% or higher, must pass the stress test. In Canada, anyone with a down payment of less than 20% must get mortgage insurance – which protects the lender if the borrower defaults on the loan. The higher the mortgage amount, the more expensive these insurance premiums are, which is why those applicants currently undergo stress tests.
The stress test shows how much money you would pay at the five-year average posted rate or a rate that is 2% higher than the actual mortgage rate offered.
There are 2 ways to calculate how much you would be paying
- Gross debt service (GDS) ratio. This is the percentage of your pre-tax income you’ll use to pay for housing costs including your mortgage, utilities, and property taxes. It should be no more than 35%.
- Total debt service (TDS) ratio. This includes all of your outstanding personal debt (mortgage, car loans, credit card, lines of credit, etc.) It should be no more than 42% of your pre-tax income.
Why do they have stress tests?
The Canadian government implemented the stress test back in 2018. These rules were designed to protect the housing market and to avoid the economic risks associated with even a slight increase in interest rates. Passing a stress test is like a shield of protection so that, if interest rates rise, you won’t have to give up your house.
Will you pass the stress test?
To determine if you’re able to afford a mortgage, the lender will look at:
- The amount of the mortgage;
- Current interest rates;
- Mortgage amortization period;
- Your household income;
- Housing costs and/or monthly condo fees;
- Your current debt.
If you look to purchase a house that costs less than you can afford, you have some leeway if there is an economic crash or if interest rates rise again. You don’t want to end up with a dream home that you really can’t afford.
What if you fail the stress test?
The worst-case scenario is that you will have to wait a bit longer to get approved for a mortgage. However, the good news is you’ll be saving your hard-earned money in the meantime which you can use to invest in your down payment, reduce debt, or save for a rainy day.
If you’re determined to invest in a new home now but don’t pass the new stress test, there are still a few options to explore.
- Improve your application by getting a co-signer who has solid financial standing
- Put more money towards your down payment to pass the stress test
- Delay buying a home and rent a little longer
- Buy less – such as a condo or townhome
- Apply with a broker or credit union as the new stress-test regulations don’t apply (at the moment) to provincially regulated credit unions
What’s different about a stress test in 2022?
The stress test interest rates went down during the first year of COVID-19, helping to ease the financial burden on Canadians looking to buy a house. So what is the stress test looking like in 2022? Well, as of June 2022:
According to a Canadian Mortgage Trends post on June 20, 2022, “Most 5-year fixed mortgage rates are already over 5%, making their stress test a full 2% higher at 7% or more. Concurrently, the mortgage stress test rate for variable mortgages is still a comparatively low 5.25% or so. In order to maximize the amount homebuyers can qualify for, many borrowers are choosing a variable-rate mortgage, even if their actual personal preference is for a fixed-rate mortgage.”
Options for today’s borrowers
Currently, a variable rate mortgage has a stress test of 5.25% (as of June 2022). However, this may change as are interest rates expected to rise. It’s predicted that they will increase to 6% by mid-July. My advice is to select a shorter fixed-term mortgage. Currently, 2 and 3-year fixed rates are below 5% so there is a small advantage over the 5-year fixed rate.
How can a mortgage broker help you with your stress test?
Working with a mortgage broker like myself, Darren Robinson, is an especially good plan if you are not sure you can pass the stress test. I can help you find the best possible mortgage options, coach you through the process, and help you avoid any mortgage regulation-related stress. Whether you’re looking for a first mortgage or a renewal, it’s always a good idea to talk to a mortgage broker because my job is to shop around for the best interest rates and give you solid advice about your options. Click here to book an appointment with me online, or give me a call at 705-315-0516 to talk about your mortgage options when it comes to buying your next home.