Homeowners who overleverage themselves when financing a home can find themselves in financial hot water when interest rates go up, sometimes unable to keep up with their increased mortgage payments. Plus, the increasing household debt in Canada can thin out bank accounts and make it more difficult to keep up with bill payments.
To curb this situation, the mortgage stress test was introduced to ensure mortgage applicants can make their mortgage payments even if mortgage rates rise. But this made it tougher for Canadians to get approved, especially for higher mortgage amounts. And with the new stress test minimum qualifying rate requirements, getting approved for a mortgage can be even tougher.
Key Points
- Borrowers applying for a mortgage with a federally-regulated lender must undergo the mortgage stress test.
- Recently, the minimum qualifying rate for the stress test has been changed to the greater of the contract rate + 2%, or the benchmark rate of 5.25%.
- The mortgage stress test applies to both insured and uninsured mortgages.
What Is The Mortgage Stress Test?
The purpose of a mortgage stress test is to protect borrowers from defaulting on their home loans should there be an increase in interest rates in the near future. If rates increase at some point throughout the loan term, some borrowers may be unable to manage higher mortgage payments when it comes time to renew. In turn, this could increase the likelihood of defaulting on their mortgages, placing both lenders and borrowers at risk.
The mortgage stress test was established as a way to prevent such unfortunate situations from happening if rates increase. The test was created by the Office of the Superintendent of Financial Institutions (OSFI) to deal with the high level of Canadian household debt.
But this was originally applicable only to mortgages with less than a 20% down payment and subject to mortgage default insurance. It has applied to insured borrowers since October 2016, after which the stress test for uninsured mortgages took effect in January 2018.
What Are The New Changes?
The latest stress test rate is the greater of the interest rate offered by their lender plus 2%, or the current Bank of Canada five-year benchmark (which is currently 5.25%).
For instance, under the new stress test rate rule, if you qualify for a mortgage rate of 6.95%, you would have to qualify at 8.95% (6.95% + 2%), since this is greater than the current benchmark rate of 5.25%.
Borrowers must have an income high enough and debt low enough to make mortgage payments if rates increase. As such, the loan amount that can be borrowed would be lower based on today’s stress test requirements versus if there was no stress test required at all.
Mortgage Stress Test For Both Insured And Uninsured Mortgages
Not only are insured mortgages subject to the mortgage stress test but now borrowers with uninsured mortgages also have to undergo OSFI’s stress test. The stress test also applies in the following scenarios:
- Buying a home
- Refinancing a mortgage
- Switching lenders
- Applying for a second mortgage
- Applying for a HELOC (home equity line of credit)
If you’re keeping the same lender when you renew, you won’t have to go through the mortgage stress test again. The test applies if you’re switching lenders when you renew and have an uninsured mortgage.
Canadian Mortgage Charter Relieves Insured Mortgages From Stress Test When Switching Lenders At Renewal
According to the recent Canadian Mortgage Charter, the mortgage stress test requirement for insured mortgages when switching lenders upon renewal has been lifted. That means if you have an insured mortgage and want to change lenders when it’s time to renew, you won’t have to undergo the stress test again. However, the stress test still applies for uninsured mortgages upon switching lenders at the time of renewal.
Some critics argue that the stress test should not include those renewing their mortgages with a new lender, regardless of whether the mortgage is insured or uninsured. However, OFSI maintains that requiring the stress test with a new lender for uninsured mortgages allows for more robust underwriting to evaluate the borrower’s financial health.
Why Are Changes Being Made To The Stress Test?
Given very high home prices across Canada and inflated interest rates, many home buyers are overleveraging themselves when they take out a mortgage to finance a home purchase. In turn, this places them at a greater risk of defaulting on their mortgage.
To make sure these borrowers are capable of managing their mortgage payments even if rates increase over their loan terms, the stress test is implemented. The increase in the new stress test rates might make it more difficult for borrowers to get approved for a mortgage for higher loan amounts. But, it will prevent them from taking out loans too big to handle.
What Impact Will The New Stress Test Rate Have On Borrowers?
Requiring borrowers to qualify for a mortgage at a higher rate will make it more difficult to get approved for larger loan amounts. Ultimately, a higher minimum qualifying rate will reduce borrowing power among home buyers in Canada.
Further, it will also have a major impact on first-time home buyers who are more likely to make down payments of less than 20% of the purchase price of a home.
What If I Fail The Mortgage Stress Test?
If you’re unable to pass the stress test or can’t qualify for the loan amount you want, consider doing the following:
- Increase your down payment amount. Making a bigger down payment means borrowing less. The lower your loan amount, the higher the chances of qualifying for a mortgage and passing the stress test.
- Buy a cheaper home. A less expensive home means you’ll need a smaller loan amount. You may have a better chance of qualifying for financing on a more affordable home.
- Increase your income. If possible, increase your income by taking on a side gig or waiting until you get a pay raise. A higher income will reduce your debt-to-income (DTI) ratio, which can help you increase your chances of loan approval.
- Pay down your debt. Much like the effect that boosting your income has on your DTI ratio, paying down your debt can do the same. Take some time to pay down your debt before applying for a mortgage.
Final Thoughts
It’s been tough for many Canadians to break into the housing market, especially after the mortgage stress test came into effect for both insured and uninsured mortgages. However, the changes are ultimately designed to keep borrowers out of financial trouble while protecting the lending industry from taking on too many high-risk mortgages.
New Mortgage Stress Test FAQs
How can I avoid the mortgage stress test?
Do I have to undergo the mortgage stress test if I renew my mortgage?
How can I find out if I’ll pass the stress test?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
