How to Stress Test Your Mortgage 2018
Are you ready to become a homeowner? Then again, maybe you’re already a homeowner, but your mortgage is up for renewal, or you’re looking to upgrade to something more higher end than your current dwelling. Not so fast, because there’s one thing that might get in your way, the new OSFI Mortgage Stress Test.
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What is the New Mortgage “Stress Test”?
So, what exactly is a mortgage stress test you might ask? It’s something that you’re likely to come across, if and when you apply for a mortgage with a traditional lender these days. Unfortunately, recent studies have shown the average level of household debt in Canada has been growing over the last few years. Essentially, with the gradual rise of housing and interest rates across the country, many would-be homeowners have been buying up houses that they won’t be able to afford in the years to come. In fact, according to the Canadian Real Estate Association, the average price of a house in August 2017 was an estimated $472,247, which is a 3.6% increase from last year.
Notable Changes to Canadian Mortgage and Housing Rules
In an effort to alleviate the country’s household debt problem, the Office of the Superintendent of Financial Institutions Canada (OSFI) proposed some changes to Canadian mortgage and housing rules in July of 2016. One of which is the implementation of a new mandatory “stress test” for potential homeowners who are borrowing through federally regulated lenders, such as banks. Originally, the test only applied to people applying for high-ratio mortgages, meaning those who weren’t making more than a 20% down payment, and therefore required default mortgage insurance. The test also included homeowners with a mortgage term of fewer than 5 years. However, as of October 17th of 2017, all candidates, even those applying for conventional uninsured mortgages (more than a 20% down payment), will have to take the test. This new regulation, which applies to both new applicants and current borrowers planning on switching lenders when their mortgage term ends, is due to take effect on January 1st, 2018.
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How Does a Stress Test Work?
From a financial perspective, a stress test is just how it sounds. It’s a way of testing how you and your finances might be affected by a sudden bout of financial turmoil, such as a loss of employment. When it comes to mortgages, it’s how you, as the potential homeowner, would cope with your mortgage payments in the event that your interest rate rises or you suffer a financial emergency of similar circumstances. Simply put, the stress test forces you to come face-to-face with the very high costs of being a homeowner. So, all potential homeowners will now need to prove they can afford their potential mortgages based on their lender’s minimum “qualifying rate”. For federally regulated institutions, this refers to the Bank of Canada’s current five-year benchmark rate, which as of October 17, 2017, is 4.89%. However, it might also be based on their contract rate (the rate they’ve been quoted and agreed to), plus two percentage points.
Canadian Mortgage Stress Test Examples
A family with a gross yearly income of $100,000 qualifies for a five-year fixed-rate mortgage at 2.83%, slightly more than two points below the benchmark rate. They have a 25-year amortization period and are making a 20% down payment. If they applied before January 1st (2018), they could afford a home that’s worth $726,939. However, if they were to apply after January 1st, and were subjected to the stress test based on the 4.89% benchmark, they would only be able to afford a home worth $570,970.
The same family with the same income qualifies for a five-year, fixed contract rate mortgage at 3.09%, with a 25-year amortization period and a 20% down payment. Up until January 1st, that family would have been able to afford a home worth $706,692. However, after January 1st, 2018, when their stress test is based on their contract rate, plus two percentage points (now 5.09%) the family will only be able to afford a house worth $559,896.
Interested in knowing how much it costs to buy a house in your city? Check out this infographic.
How to Perform Your Own Stress Test
The first thing to do, before you go weighing your income against the current interest rates in your area, which might be favorable at the moment, is to go ahead and assume that rates in the future may not be. This is especially true for those with a variable rate mortgage. Being that variable rates are determined based on prime rate, if you have one, your mortgage is going to be immediately impacted by a rise in general interest rates. While homeowners that have a fixed rate will continue paying their regular, low-interest rate, that won’t be the case once their term is over and their mortgage is due to be renewed. So, assume that an increase of around 1-2% over the coming years is within the realm of possibility.
A Basic Example
So, let’s say you’re looking to buy a house at the current average housing price in August (2017), which was $472,247. You decide to make a 20% down payment, with a 5-year fixed rate of 2.84%. This means your monthly mortgage payment is $1,757. However, in a typical stress test, you’ll add a subsequent 2% to your rate, bringing your monthly payment to $2,163. The same sort of idea goes for anyone with a variable rate or who isn’t making more than a 20% down payment and therefore needs to pay for default mortgage insurance. So, weighing these costs against your income, coupled with all your other living and home-related costs, property taxes and financial emergencies, would you still be able to afford your mortgage payments? If there’s even a small possibility that you won’t be able to keep up with your payments, it might be better to either hold off until you can make a better income or simply look for a house that’s within a more reasonable price range.
Consult our mortgage calculator for a better idea of what you’ll be paying.
While the introduction of this new stress test is predicted to decrease both the cost of homes, as well as the business profit margin for federally regulated lenders, it could actually be seen as a benefit for alternative lenders. Being that private and small subprime lenders don’t rely on funding from banks, and credit unions are provincially regulated, financial experts speculate that this is where many borrowers will turn when they don’t qualify at a bank. So, if you’re one of those prospective homeowners, alternative subprime lending might be a viable option for you.
Higher Interest Rates
However, it’s important to be aware that the interest rates most alternative lenders charge are higher than those of a traditional lender. In fact, with these new housing regulations, alternative lenders have come into a position where they’re able to charge even more for their services. Many people are willing to pay those prices if they don’t qualify anywhere else. Then again, since alternative lenders aren’t funded by anyone but themselves, they’re also becoming a bit more particular about which clients they’re willing to lend money to. One way of narrowing this gap is by raising their interest rates. So, while you might qualify easier with a non-traditional lender, it’s good to keep these issues in mind before you apply with one, as it could end up costing you more down the line.
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Predicting The Housing Market
In the end, it’s become difficult to predict what the real estate market will look like in the years to come. Since the price of homes and the cost of interest have been on a steady rise, it’s no wonder that the government is worried about just how bad the level of household debt amongst homeowners can get. So, whether or not you agree with the OSFI’s new housing regulations, the mortgage stress test will soon be a mandatory trial that all potential homeowners and those switching lenders must endure. If you’re applying for a high-ratio mortgage, you may have recently had to take the stress test. Or, maybe you have a basic understanding through an online mortgage calculator or through your own calculations. Either way, it’s possible you’ve suddenly discovered that you can’t afford as much house as you were initially hoping.
Look on the Bright Side
Disheartening as that thought might be, the mortgage stress test is a good way of ensuring that you don’t end up under a serious amount of debt that you won’t be able to handle over time. True, you may not have the home you dreamed of, at least at first, but you also won’t be getting in over your head. Overall, living in a less expensive home might not be that bad of a price to pay, considering what could happen to your finances and family should your level of household debt get out of hand. If you don’t mind waiting a while, you can work hard, save up more money, and one day be able to afford the home that you really want.