Buying a home is one of the most arduous and expensive purchases that most will take on in their lifetime.  As of February 2022, the start of the Bank of Canada’s 8 consecutive rate hikes has driven up the cost of borrowing – making this process even more difficult and expensive.

Canada’s federal stress test requires borrowers to prove their ability to carry a mortgage if mortgage rates should surge – very much like the current financial environment. The stress test limits borrowers’ debt by testing their ability to qualify with a higher interest rate.  This article will provide you with the know-how and insights to confidently stress test your ability to carry a mortgage.

A Primer on the Stress Test

The stress test is a requirement by the federal government for lenders to assess the borrowers’ risk by having them qualify for a mortgage at a rate higher than their contract rate.  The stress test is a financial calculation to ensure you qualify for your mortgage payment if rates rise.

The stress test was introduced after the 2008 recession when the subprime mortgage market collapsed in the US.  As US dollars are the defacto reserve currency of most of the world, its valuation and devaluation affect many countries’ purchasing power. 

With this premise in mind, countries worldwide began solidifying their mortgage lending criteria with the Basel Guidelines (B-20) that came into place – known by various names, including the Dodd-Frank Act in the US. In Canada, it was aptly known as the stress test – since the government intended to stress test the borrower’s ability to carry a mortgage over long periods, such as when it takes to payout a mortgage.

In November 2016, all lenders needed their insured mortgages to follow the insured lending criteria, be limited to occupied residences, 25-year amortization and a maximum home price of $1 million. This limit applied even if the borrower put down 20% or more down payment, at which point the lender paid for the default insurance on the back-end (portfolio insurance). 

The stress test was expanded by incoming international Basel II guidelines in January 2018, similar to what we know today. All mortgages, insured or uninsured, had to be stress tested by the greater of the benchmark rate or the contract rate plus 2%. Additionally, that same year, the government limited any property’s loan-to-value (LTV) ratio to 80% if the mortgage or transaction is uninsured (meaning property value is $1 million or more, or the amortization chosen exceeds 25 years, or the borrower is refinancing the property). For example, if the property was uninsured, it was limited to 80% LTV maximum regardless of whether it had a secondary mortgage charge. 

The stress test not only uses a mortgage payment calculated on a rate which is 2% higher than the borrower’s contract rate but also limits the use of gross income that can service the qualifying to 39% of the borrower’s or borrowers’ (in a joint application situation) gross household income. The government regulator, the Office of the Superintendent for Financial Services (OSFI), has made overtures that the rules need to be tightened further.

The possibility of further tightening mortgage lending, the new Tax-Free First Home Savings Account (FHSA), and a lack of home listings due to downward pressure on home prices from the federal government rate hikes are all working in tandem to take housing unaffordability to new heights.

Stress Test Rate Historical Changes

Years back, qualifying for a mortgage in Canada was much more manageable. In fact, before the 2008 financial crisis, it was probably too easy to qualify for a mortgage. CMHC used to insure 40-year amortizations, and you could buy a house with zero down payment!

There was no stress testing until 2016. Uninsured mortgages with over 20% downpayment weren’t required to be stress-tested until 2018. And even then, if you chose a 5-year fixed rate, as most Canadians did, you qualified for your mortgage as long as you could afford your actual payment.

Since then, many things have changed. Now every regulated lender stress tests all the mortgage business they take on.  Last year housing prices were super high as rates were super low. This year, the housing prices are super low, and the rates are super high – both effectively being a roadblock to the average Canadian’s dream of becoming a homeowner.

Even when mortgage rates were ultra-low last year, the benchmark or mortgage qualifying rate stayed much higher. Strangely over the past 12 months, the fixed and variable rates have been markedly higher than the benchmark (mortgage qualifying rate) stress test.

Here is a look back on the qualifying mortgage rate and average uninsured 5-year posted rate since the stress test was hatched:

Date of Change	Mortgage Qualifying Rate	Average 5-Year Fixed (Uninsured) Rate
October 2017	4.99%	2.83%
January 2018	5.14%	2.79%
May 2018	5.34%	3.09%
July 2019	5.19%	2.49%
March 2020	5.04%	2.24%
May 2020	4.94%	2.14%
August 2020	4.79%	1.74%
June 2021	5.25%	1.68%
December 2022	5.25%	5.34%

Stress Test 101

A mortgage stress test confirms whether you can afford mortgage payments if interest rates increase. Interest rates will fluctuate over the life of your mortgage and affect your mortgage repayments.  OSFI requires prime and other regulated lenders to use mortgage stress testing as a qualification prerequisite to protect themselves from taking on excess risk.

This section has compiled the 3 most significant factors limiting a borrower’s qualifying mortgage amount.

Limiting Factor	Limit Impact	Limit Applied
Rate	A higher rate used for qualifying will require a higher income to service the stress-tested mortgage payment.	Qualify at greater of BoC Benchmark or contract rate plus 2%.
Loan-to-Value (LTV) Ratio	The lowest rates are reserved for higher LTVs.	Client needs a minimum 5% downpayment or equity in the subject property for the first $500K and a 10% portion of property value exceeding $500K. The client needs a minimum 20% downpayment or equity for property valuations exceeding $1 million.
Debt Service Ratios	Only a portion of the gross household income is used to service gross and total debt.	Gross Debt Service (GDS) ratio is limited to 39% of income for insured or insurable mortgages/transactions where the amortization does not exceed 25 years.

How to Calculate Your Mortgage Qualifying (Stress Test) Rate

The easiest way to calculate your mortgage stress test is to add 2% to your rate and compare it with the benchmark rate:

You can check out nesto’s best 5-year variable rate or best 5-year fixed rate, then add 2% to your rate choice to get your higher stress test rate.

• The Bank of Canada Benchmark Rate, currently 5.25%, or
• Your mortgage interest rate + 2%

For example, if you’re choosing nesto’s fixed rate, which today (as of April 18, 2023) is 4.39%, and you match the LTV limitations for this rate, then calculate your mortgage qualifying (stress test) rate as:

4.39% + 2% = 6.39%

Since the Bank of Canada’s benchmark rate of 5.25% is lower than 6.39%, you would use the higher 6.39% for your mortgage to be stress tested on.

Or, for example, if you’re choosing nesto’s variable rate, which today is 5.50%, and you match the LTV limitations for this rate, then calculate your mortgage qualifying (stress test) rate as:

5.50% + 2% = 7.50%

Since the Bank of Canada’s benchmark rate of 5.25% is lower than 7.50%, you would use the higher 7.50% as your stress test rate.

Then, simply input your stress test rate into our mortgage calculator to calculate your stress test monthly payment for your desired mortgage amount.

If your monthly housing expenses are less than 39% of your monthly income, you pass the stress test for that mortgage amount.

Mortgage Stress Test Example

You and your partner plan to buy a home in Montreal for $800,000 and have a 20% down payment saved. You plan to borrow the remaining 80% for a $640,000 mortgage.

You both have excellent credit and want nesto’s best 5-year fixed rate of 4.59% (the correct rate for 80% LTV). Referring back to our stress-test mortgage qualifying rate, since 5.25% is lower than 4.59% + 2%, we’ll use 6.59% to calculate the qualifying (stress-tested) mortgage payment. 

For a mortgage of $640,000 over 25 years (nesto’s lowest rates are reserved for insured or insurable transactions, which are limited to a 25-year amortization), we’ll use nesto’s mortgage payment calculator and get a payment of $4,321.85/month. (Remember, this is the qualifying payment and not your actual mortgage payment, which is $3574.32/month).

MLS listing for the subject property shows that the taxes last year were $3900 annually, and the house is 1800 square feet.

Total monthly housing costs are:

  $4,321.85/month as the qualifying (stress-tested) mortgage payment

+ $325/month property taxes (or $3,900 / 12 months)

+ $150/month in heating costs (heat is usually calculated as $0.05/sq.ft/month with $150 being a minimum)

_______________

= $4796.85/month 

You work full-time with a bonus, and your T4s from the past 2 years average $80,000/year. 

Your partner makes $90,000/year without a bonus. 

Your total household income is $80,000 + $90,000 = $170,000/year, or $14,166.67/month.

Dividing total monthly housing costs by monthly household income gives us the following:

$4796.85 / $14,166.67 

__________________

33.86% is under the 39% gross debt service (GDS) ratio threshold, which may be acceptable for most lenders.

The second ratio you both have to pass is the total debt service (TDS) ratio threshold, which limits gross income’s use to 42% to 44% to service all debts – including the household debts (that were included in the calculation of the gross debt service ratio).

$14,166.67 x 42% – $4796.85 = $1,153.15

$14,166.67 x 44% – $4796.85 = $1,436.48

You’ll have between $1,153 and $1,436 to service your debts. To ensure you’ll qualify with all lenders, aim to stay within $1,153 monthly.

$1,153 / 5% = $23,060 (this is the total limit of balances you can carry on all revolving accounts such as credit cards and lines of credit)

You can debt-service up to a $23,000 balance on revolving credit which requires a 5% repayment monthly in QC even if the actual minimum payment is lower. 

($1,153 – $500) / 5% = $13,060 (this is the total limit of balances you can carry on all revolving accounts such as credit cards and lines of credit when you also have $500 monthly on loan payments)

Conversely, you could debt-service up to a $13,000 balance on revolving credit if you also have a $500/month payment on loans (auto or student loans) or any combination thereof as long as you don’t exceed your total debt servicing (TDS) ratio of 42%.

Final Thoughts

Housing prices go up and down. Rates go up and down. Credit scores go up and down. Your savings and downpayment can also go up and down. A lot can change month over month in today’s fast-paced, inflation-driven housing and mortgage market.

Don’t stress about the stress test! Use nesto’s mortgage payment calculator or mortgage affordability calculator to stress test your perspective mortgage solution.  Consider speaking with one of nesto’s commission-free mortgage experts to help guide you with the insights to make an informed decision about your biggest investment! 

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