If you’re planning to buy a home with a mortgage, you’ve probably heard the term “mortgage stress test.”
Over the past few years, the mortgage stress test become a regular aspect of home buying in Canada and plays a big role in determining the size of the mortgage you can be approved for based on your income and debt.
If you’re getting ready to buy a new home, or to refinance or transfer a mortgage on your current home, here’s what you need to know about the mortgage stress test.
» MORE: How mortgages work in Canada
The mortgage stress is a mandatory evaluation that determines how much mortgage you can afford based on your personal financial circumstances. The test became mandatory for mortgages offered by federally regulated lenders (such as Canada’s major banks) in 2018.
All Canadian home buyers are obligated to undergo the mortgage stress test when applying for a loan from a federally regulated lender, even buyers who have a down payment of 20% or more. Individuals who refinance their mortgage, take out a home equity line of credit, or switch to a new lender also have to take a mortgage stress test.
The term “test” makes the mortgage stress test sound a lot more difficult and daunting than it really is. It’s more of a calculation that helps lenders understand whether you’d be able to keep up with your mortgage even if your payments increased in the future.
To pass the Canadian mortgage stress test you need to prove that you can afford payments at the current qualifying mortgage interest rate. The qualifying interest rate is usually higher than the actual interest rate in your mortgage contract. This rate is revised at least once a year by the Department of Finance and the Office of the Superintendent of Financial Institutions, a federal bank regulator, to make sure it reflects the current status of the economy.
The stress test compares your income to your debts, property costs and potential mortgage payment. These comparisons are known as your gross debt service (GDS) and total debt service (TDS) ratios. To pass the test, your GDS ratio should be under 39% and your TDS ratio must be under 44%, even with the assumption of a higher qualifying mortgage interest rate.
» MORE: What are debt service ratios?
The stress test became mandatory in 2018 for borrowers applying for uninsured mortgages — those with down payments of more than 20% — from federally regulated lenders such as banks. In June 2021, the stress test was updated to include both uninsured and insured mortgages, and to use higher qualifying rates. Mortgage rates are expected to increase from the all-time lows seen over the past few years, and the government said it wants to protect buyers from defaulting on their mortgages and losing their homes.
As June 1, 2021, the minimum qualifying rate is the higher of either:
Prior to this change, the minimum qualifying rate was the higher of either 4.79% or the borrower’s rate plus 2%.
What do these changes to the mortgage stress test mean for homebuyers? A more stringent stress test could definitely make things more difficult for first-time home buyers, who may realize the price range they hoped for is out of reach with their current income and debts. While that 0.46% difference may seem small on paper, when you consider it in the context of housing prices, it can add up to thousands of dollars.
» MORE: What is mortgage insurance?
Before you apply for a mortgage and undergo an official stress test with a lender, you can stress test yourself to get an idea of whether or not you will pass. The easiest way to do this is with an online calculator like this mortgage qualifier tool from the Financial Consumer Agency of Canada.
First, you’ll enter information on property costs, unsecured debt balances, and monthly debt payments as well as your income and the potential mortgage information, like down payment and interest rate. Then, the calculator will show you if you fall within the limits of being approved, based on the information you entered.
Note that these online calculators are not replacements for mortgage pre-approval, and the results may differ from a mortgage lender’s official stress test. But, they will give you an estimate of how much you can afford or whether you might need to decrease your debt-to-income ratio before you can be approved.
Hannah Logan is a writer and blogger who specializes in personal finance and travel. You can follow her personal travel blog EatSleepBreatheTravel.com or find her on Instagram @hannahlogan21.