For many Canadians, the next step after completing their education and securing a job is buying a home. Home ownership is, after all, the Canadian dream. While it’s common knowledge that saving up for a down payment is the first step to eventually buying a home, many are not aware of the mortgage stress test. So, what is the mortgage stress test in Canada?
To put it simply, the mortgage stress test is a mortgage qualifier tool used to determine if the borrower would still be able to continue making mortgage payments, should they lose their job, undergo some other type of financial strain, or if interest rates were to rise.
Before being approved for a mortgage on a home, the borrower must pass the mortgage stress test. Upon passing the mortgage stress test, the borrower can be pre-approved for a house loan.
However, the borrower may also choose to borrow funds through a credit union or another type of non-federally regulated lender, and in this instance, would not need to pass the mortgage stress test.
Even if you already have a mortgage, you may be required to pass this test. For example, if you refinance your home or take out a home equity line of credit (HELOC), your bank will require you to pass the test. Read on to learn more about the mortgage stress test, including changes to the test that may impact your pursuit of the Canadian dream.
The Mortgage Stress Test
When discussing mortgage rates and purchasing a home, most people focus on the interest rate. This is because the interest you pay on a loan to buy a home adds up, and can potentially add hundreds of thousands of dollars to the cost of your home.
Some Canadians opt for a variable interest rate when purchasing their home. This means that the interest they pay over the length of the loan varies with a positive correlation to the Bank of Canada interest rate as it fluctuates. This variance adds uncertainty to the mortgage equation, meaning that banks and lenders want to eliminate as much risk as possible of a borrower not being able to pay the loan. In that, the mortgage stress test is used to determine the borrower’s risk associated with fluctuating interest rates.
To pass the test, prospective borrowers must prove they can carry their mortgage at a rate of 5.25 per cent, or their contract rate plus two per cent – whichever is higher. The flat rate is the standard rate used to qualify uninsured and insured mortgages.
The increase in the assessment rate for the stress test has decreased the purchasing power of many prospective homebuyers in Canada because they are being assessed at a higher rate than before. This means that in the past, someone would have been approved for a higher mortgage than they would be approved for now. This new assessment rate has also made it increasingly difficult for current homeowners to renew their mortgages. Combining the increased rate with rising prices and the financial effects of the pandemic, it is no wonder some Canadians are worried about mortgage approval.
Impacts of the Mortgage Stress Test on Canadians
While the increased qualifying rate for the stress test helped limit the chance of mortgage loan defaults and decreased the uncertainty for lenders, it has made it more difficult for Canadians who want to buy a new home. The “stress test rate” rate is used to determine how much loan a buyer could afford, even though it is quite a bit higher than the actual interest rate you would pay on your mortgage. At today’s interest rates hovering above five per cent, you’d have to qualify at a rate of over seven per cent or more.
However, in response to today’s higher interest rates and pressure from the mortgage industry, the OSFI has announces a change to the mortgage stress test: effective November 21, 2024, homeowners will no longer be stress-tested when switch their uninsured (conventional) mortgage to another lender at renewal.
If you are a prospective homebuyer, we recommend speaking to a mortgage professional or financial advisor to help you navigate the home-buying process. Further, a key takeaway is that the higher down payment you put on your home, the lower the mortgage required, minimizing the impacts of the new mortgage stress test.
When you’re ready to buy, ensure you work with an experienced, professional real estate agent who can help you navigate the market. Click HERE to find a RE/MAX agent near you.
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