The Canadian Mortgage Stress Test in 2019
Meeting the requirements for a mortgage and getting approved are already challenging enough, but securing a mortgage in 2019 is even more of a feat thanks to the recently introduced mortgage stress test.
Want to know the minimum credit score required for a mortgage in 2019? Find out here.
In 2018, all Canadian buyers who are applying for a mortgage from a federally-regulated lender were required to undergo the OSFI Mortgage Stress Test, including those who put at least 20% as a down payment.
This certainly affected homebuyer hopefuls, as their finances were even more closely scrutinized before gaining mortgage approval. Basically, borrowers were – and continue to be – forced to prove their ability to make mortgage payments, even in times when interest rates go up.
So, how will Canadians deal with the mortgage stress test in 2019 and beyond? And how will this stress test continue to be a part of the homebuying process?
Let’s look at the new mortgage rules in greater detail and how it impacts home buyers in 2019.
Canadian Mortgage Stress Test Explained
The mortgage stress test is designed to make sure that Canadians who are applying for a mortgage are able to make their payments even if rates increase in the future.
In order to pass the mortgage stress test, you’ll need to qualify at your contracted mortgage interest rate plus 2% or the Bank of Canada’s current five-year benchmark rate, whichever of the two is greater. As of this writing, the Bank of Canada’s five-year benchmark rate is 5.34% and has been there since May of 2018.
For example, if you are applying for a mortgage at a rate of 3.65%, then your lender will assess you as if you were paying your home loan at 5.65% (3.65% + 2%) since 5.65% is greater than the Bank of Canada’s five-year benchmark rate.
Because of this stress test, the majority of new homebuyers have had their purchasing power slashed by as much as 20% because they’re only eligible for a lower loan amount at the mortgage stress-tested rates. The new stress test rules have also made it more difficult for current homeowners to refinance or renew their mortgage.
Read this to learn how the mortgage stress test could affect your refinancing plans.
What is the Purpose of the Stress Test?
Basically, the stress test was designed to tackle the household debt issue in Canada and prevent consumers from getting themselves into even more debt by taking on a mortgage that’s too big for them. The average household in Canada is indebted at 170% of their disposable income, which means that Canadians owe $1.70 for every dollar they earn after taxes.
In an effort to deal with this mounting issue, the Office of the Superintendent of Financial Institutions Canada (OSFI) made some changes to the mortgage and housing rules. Originally, the mortgage stress test was only applicable to Canadians who were applying for high-ratio mortgages (mortgages with less than a 20% down payment and therefore subject to mortgage default insurance premiums).
But as of October 2017, all mortgage applicants – including those applying for conventional mortgages with at least a 20% down payment – are now required to undergo this test. This regulation is also applicable to those who wish to change to a different lender when their mortgage expires.
Click here to discover the difference between collateral and conventional mortgages.
How to Prepare For the Mortgage Stress Test
There’s not much that can be done about the benchmark rate and the rate that your lender is charging you, but it would help to have a basic understanding of where you stand before you apply for a mortgage. Ideally, you should chat with a mortgage broker or real estate agent.
Lenders use a few key metrics when assessing borrowers to make sure they’d be able to pass the stress test and manage mortgage payments, including the gross debt service ratio (GDS) and total debt service ratio (TDS).
Be sure to read this before you miss a mortgage payment.
Gross debt service ratio (GDS) – Your GDS represents the percentage of your pre-tax income that’s required to pay all housing costs. Your lender will not only look at your stress-tested monthly mortgage payment, but the cost of all other monthly expenses, including condo fees, utility bills, and property taxes.
All of these costs will be added together and divided by your gross monthly income. Ideally, lenders want to see a percentage of no more than 32%.
Total debt service ratio (TDS) – All your debts will need to be factored into the equation as well, which is why lenders will also look at your TDS. This represents how much of your monthly income is needed to adequately cover your debts.
For more information about your debt service ratio, check this out.
That includes car payments, personal loans, student loans, credit cards, lines of credit, and so forth. When all of these are added up, your TDS should be no more than 42% of your gross monthly pay in order to get approved.
To better prepare yourself for the stress test, consider taking the following actions:
Pay down your debt. As already mentioned, your lender will look at all the debt that you currently carry and factor it into their assessment of whether or not you’d be eligible for a mortgage. The smaller your current debt load, the lower your TDS will be.
In turn, your stress test results may be more favourable. Focus on paying down your high-interest debt first (such as your credit cards) to avoid paying so much in interest charges.
Apply for a smaller loan amount. Be realistic about how much house you can actually afford. You might have your sights set on a home in the $800,000 price range, but perhaps you might make things a lot more financially feasible for yourself if you look at homes in the $600,000 range instead.
Not only will this increase your odds of passing the stress test and getting approved for a mortgage, but it can also free up more of your income and prevent you from going “house poor.”
Crunch some numbers. Ask yourself if you could really afford to pay an additional $500, for example, in mortgage payments if rates suddenly increase after you’ve been approved.
You might be comfortable making $1,000 mortgage payments every month, for instance, but what if you were required to throw in an additional $500? Would that be doable? Or would that throw you into a financial frenzy?
Wondering why different lenders offer different mortgage rates? Look here to find out.
That’s exactly why this stress test was implemented. Should you be faced with higher rates in the near future, your lender would want to make sure you’d still be able to make your payments in full every month rather than face defaulting.
Can I Avoid The Stress Test?
The stress test is designed for federally-regulated banks. But some mortgage lenders, such as credit unions and private lenders, are not under OSFI’s jurisdiction.
As such, lenders like these are not required to put their mortgage applicants through these stress tests the way traditional banks and other federally-regulated lenders must.
Click this link if you can’t decide whether to work with a bank or mortgage broker.
If you’re looking to avoid these stress tests, you may want to consider applying for a mortgage or renewing your current mortgage with a lender that does not fall under the jurisdiction of the OSFI. This, in turn, will give you more purchasing power.
The Future of The Stress Test
Many applicants have already felt the wrath of the incredibly stringent rules of the mortgage stress test and have had their purchasing power reduced. As a result, the mortgage stress test rules have come under great scrutiny over the last year, and as such, there is mounting pressure on the OSFI to ease the rules.
While the intention of the rules was to ensure borrowers aren’t increasing their risk of defaulting and to slow down the housing market to ease skyrocketing prices, opponents suggest that the rules are simply too harsh.
Since the introduction of the new stress test rules, markets have certainly cooled down in many markets and interest rates have started to rise. Such a situation has prompted the OSFI to review the rules surrounding the stress test.
What does that mean for borrowers in 2019 and beyond? While the OSFI has not shown any intentions on changing the rules, only time will tell if that will change sometime soon going into 2019.
Trying to negotiate the best mortgage contract in 2019? Look here first.
Looking to Apply For a Mortgage in 2019?
Getting a mortgage can be a stressful situation, but with the right guidance, the process can be a much more streamlined one. If you’re considering applying for a mortgage in 2019, call Loans Canada to help guide you to the right lender who can offer you the appropriate mortgage product for your financial situation.