Are you hoping to buy a home in Canada but worried about passing the mortgage stress test? In some cases, it may be possible to avoid this test, which some would-be-homebuyers see as an annoying barrier to their goal of owning a house. But there are some benefits to this so-called obstacle that are worth considering. This article will explore important facts about the mortgage stress test, and ways to avoid it to secure the financing you need to buy a home.
Can You Avoid The Mortgage Stress Test In Canada?
Yes, you can avoid the mortgage stress test in Canada, as the test only applies if you get a mortgage with a federally regulated lender. So, if you apply with a private lender, you may be able to skip the stress test (though keep in mind it is designed to ensure you can comfortably pay back your mortgage if interest rates were to increase).
What Is A Mortgage Stress Test?
The mortgage stress test is a tool federally-regulated lenders use to calculate whether a borrower can still manage their mortgage payments if interest rates rise. It requires borrowers to qualify at a higher interest rate than the rate they’ll be paying. This is to ensure that they can handle potential future rate increases.
To pass the test you have to be able to afford a mortgage rate of either the interest rate you were approved plus an extra 2% or a rate of 5.25% (the minimum qualifying rate), whichever is higher. So, for example, if you were approved for a mortgage of 5%, you’d have to prove you could manage payments at a rate of 7%.
How To Avoid The Mortgage Stress Test In Canada
To avoid the mortgage stress test, you’ll need to work with certain alternative lenders. There are a few options to consider, each with unique pros and cons:
Can You Avoid The Mortgage Stress Test By Working With A Private Lender (Or MICs)?
Private lenders and Mortgage Investment Corporations (MICs) are not subject to the same regulations as traditional lenders, which means they may not require borrowers to pass the stress test.
- These lenders (which can be individuals or groups) often cater to borrowers with financial situations that conventional banks may not generally want to work with, such as those who are self-employed, have lower credit scores, or need short-term financing.
- Private lenders may charge higher rates than traditional banks because they cater to riskier borrowers.
- Private lenders often offer short-term mortgages that borrowers use as a bridge to traditional mortgages.
- Interest-only mortgages can only be secured through private lenders.
Can You Avoid The Mortgage Stress Test By Working With A Credit Union?
Credit unions are provincially regulated so they are not required to use the stress test to approve a mortgage. While some credit unions may use it to help assess your viability as a borrower, they have more flexibility when deciding whether or not to approve a mortgage.
Credit unions are member-owned, not-for-profit financial institutions that often offer lower fees, more personalized service, and easier approval processes for mortgages compared to traditional banks.
- Since credit unions are member-owned they often prioritize building relationships with their community and may offer more personalized service and have more flexible lending guidelines for mortgages.
- They may offer more competitive rates than banks.
Can You Avoid The Mortgage Stress Test By Working With A MFC?
Mortgage Finance Companies (MFCs) are non-bank lenders that specialize only in mortgages. Unlike banks, they do not provide other financial or lending products and are not subject to the same strict regulations as banks. As such, they’re not obligated to stress test borrowers. They are also more willing to lend to riskier borrowers.
Because they usually deal with mortgages sourced through brokers, they may sometimes offer lower rates than the Big banks due to increased competition (though rates will also be contingent on the borrower’s personal finances, including credit rating.
- Since the 1990s, Mortgage Finance Companies have been playing an increasingly significant role in the Canadian mortgage market, particularly in terms of originating, underwriting, and administering mortgage loans.
- Because they operate mainly online, they often offer lower rates than conventional lenders.
- They offer faster approvals and may have flexible mortgage terms, such as more frequent prepayments. They are also generally more willing to work with borrowers with lower credit ratings.
- MFCs sometimes offer other mortgage-related products like home equity lines of credit.
- They may have more flexible maximum gross debt service (GDS) and total debt service (TDS) ratios.
What Are Alternative Lenders?
An alternative lender in Canada is a financial institution other than a chartered bank (i.e. an institution that is incorporated and authorized by the federal government). These lenders operate outside the conventional banking system and offer more flexible lending criteria, catering to individuals with unique financial situations or who fail to meet the strict requirements set by traditional lenders.
Pros Of Working With An Alternative Lender
- Avoid stress test, making it easier to qualify for a mortgage
- More lenient qualification criteria, including lower credit score requirements and more flexible debt-to-income ratios
- Often has faster approval and funding available
- Often more willing to accommodate borrowers with less-than-ideal financial situations (self-employed, irregular income, etc.)
Cons Of Working With An Alternative Lender
- Some (like MICs or private lenders) may charge significantly higher interest rates compared to traditional lenders to compensate for the increased risk
- Private lenders tend to offer shorter mortgage terms, which can lead to more frequent renewals and potentially higher costs over the long term
- May have lower maximum loan amounts compared to banks or credit unions
- To compensate for taking on riskier borrowers, these lenders often charge higher fees
- Less regulated and monitored by the government compared to traditional financial institutions, meaning fewer consumer protections
- If you’re forced to go with an alternate lender because you could not be approved otherwise, it’s possible that getting a mortgage with an alternate lender (especially an MIC) could put you at financial risk
Should You Avoid The Mortgage Stress Test?
The mortgage stress test is designed to protect borrowers from taking on more debt than they can handle over the long term. While it may seem like an obstacle to getting your dream home, it’s important to ensure that your mortgage is affordable, now and for the long term.
Keeping Your Mortgage Affordable Without A Stress Test
If you opt to avoid the stress test and go with an alternate lender, there are a few ways you can ensure the mortgage you get is affordable:
- Make a larger down payment. This will reduce the amount you need to borrow and make payments more manageable.
- Stress test yourself. The government of Canada provides a free mortgage qualifying tool that can help you decide what size of mortgage you can comfortably handle.
- Get a fixed-rate mortgage. A fixed-rate mortgage protects you against interest rate fluctuations and ensures you have predictable monthly payments, which can be helpful if your financial situation changes.
- Pay down your debt. If you have a significant amount of other debt, consider consolidating it under a debt consolidation loan or combining it with your mortgage. This can simplify your payments and potentially reduce your overall interest costs.
Should You Work With An Alternative Lender?
Alternative lenders can be a good option if you are self-employed (and thus don’t have a stable income flow), carry lots of debt, or have a less-than-ideal credit history. Anyone who may struggle to get a loan with a conventional lender is a candidate for an alternative mortgage. However, while the impulse to get a home can be strong, before signing on the dotted line with an alternative lender, it’s essential to understand the potential risks and long-term costs of taking on a mortgage without the stress test.
Bottom Line
While the mortgage stress test can seem like an annoying hurdle for some borrowers, it’s important to remember that it’s intended to help predict if you can make mortgage payments in a higher interest rate environment. Avoiding the stress test can be a reasonable route to a mortgage for some people. But it’s wise to ensure buying a home is the right choice by analyzing your financial circumstances.
Mortgage Stress Test FAQs
Who sets the mortgage stress test?
Can you avoid the mortgage stress test when renewing your mortgage with a new lender?
What is the current mortgage stress test rate?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
