Whether you’re buying your first home, your next investment property or even renewing your mortgage, Canada’s mortgage stress test is a necessary step to complete before you’re able to get qualified for a mortgage. However, this isn’t your run of the mill test you have to study for: it’s a gauge of your finances created by the Canadian government to determine if you can pay off your mortgage, if interest rates were to rise.
And while it’s been around for years, many Canadians have no idea what it is or understand how it works.
The simplest way to explain the stress test is seeing it as an assessment to determine your ability to pay your mortgage. Being a homeowner comes with very high costs over an extended period of time. The government wants to protect you to ensure you don’t default, even in times of sudden financial stress or changes, like losing your job, interest rate increases, a financial emergency, etc. Ultimately, you’re proving that your finances are able to handle this long-term commitment based on the minimum qualifying rate.
When you apply for a mortgage, your lender will determine if you pass the stress test by using a higher rate than your approved rate, against your finances. This higher rate is also referred to as the mortgage qualifying rate. This rate is standardized by the Office of the Superintendent of Financial Institutions (OSFI), who sets out this rate based on the average 5-year fixed rates across the big banks in the country.
This tends to result in being able to borrow a smaller sum of money so lenders have higher certainty and security that you can repay it all.
It’s important to understand that the mortgage qualifying rate isn’t a real rate you’ll see on your mortgage documents: it’s an inflated, hypothetical rate that’s created to lower the amount of the mortgage you qualify for and create added lending security for mortgage brokers and banks.
For example, say you have a 4% fixed rate approval, the stress test will measure your finances against a 6% qualifying rate.
If you have a 2% variable rate approval, the test will benchmark you against a 5.25% rate.
For example: Let’s say you wanted to borrow $400,000 at a rate of 1.78%. You would have to prove you can afford a mortgage payment of about $2,385 per month (which is an interest rate of 5.25%), even though your actual monthly mortgage payment of $1,650 (with your actual offered interest rate of 1.78%) would be a lot lower.
Understandably, the stress test can put limitations on borrowing for many aspiring homeowners. So you may be wondering, is there a way around it? The answer is no. The Canadian stress test is a requirement for mortgage lending at major financial institutions.
If you’re worried about passing the stress test, you may want to consider getting a co-borrower or guarantor to help with the approval process.
With rising interest rates and Canadian mortgage regulations changing, the stress test may seem more intimidating than ever. But it doesn’t have to be.
Being prepared with a financial plan to save more money for a downpayment and increase your earnings can lift the weight of the stress test. And using a mortgage calculator can help you benchmark the stress test in advance before applying for your mortgage approval.
And if one-on-one time with a mortgage advisor is the next step in your journey to home ownership, feel free to connect with one of Pine’s mortgage advisors for any questions you might have about your finances or how to get approved.