What is a Stress Test?

The mortgage Stress Test is the government’s way of protecting Canadians from borrowing too heavily against their home, which for most people is their biggest asset. 

Rising home prices and low interest rates mean that everyone today wants a cheap mortgage, and lenders are all too happy to oblige. Sound familiar? 2008 (The Big Short) wasn’t that long ago, and the Stress Test was the result: a new set of rules for responsible lending practices, to ensure borrowers don’t get in over their heads, and lenders don’t get too greedy.

Of course, this time around is definitely different, with the global pandemic, supply chain issues, rising inflation, and an uncertain job market. No one knows what the future holds, but one thing you can have peace of mind about is that your mortgage approval today has been stress tested. That means you’re only borrowing what you can afford, and the payments should fit your budget now and in the future.

How to Calculate Your Mortgage Stress Test

You won’t need a treadmill for this Stress Test – just a calculator will do. 

The Stress Test is the higher of:

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

For example, let’s say you’re getting Nesto’s best 5-year variable rate of 1.25%. 

1.25% + 2 = 3.25%

Since (a) 5.25% is higher than (b) 3.25%, use the higher 5.25% for the Stress Test interest rate.

Input the Stress Test interest rate into Nesto’s mortgage calculator to calculate the Stress Test monthly payment for your desired mortgage amount. (If it seems high, don’t worry, your actual payment will be lower – this is just for testing purposes.)

If total monthly housing expenses are less than 39% of your monthly income, you pass the Stress Test! 

Monthly housing expenses include:

• the Stress Test monthly payment amount
• annual property taxes divided by 12
• average monthly heating bill (if you’re unsure, use $150)
• plus 50% of the monthly condo/maintenance fees, if applicable

If total is more than 39% of your monthly income (before taxes are taken off), that’s a red flag for lenders.

If you have a student loan, car lease, or other accounts on the credit bureau, including those monthly payments can bring you up to 44%, but anything over that is probably a hard no.

Stress Test Rate Historical Changes

Years ago, it used to be much easier to qualify. In fact, many mortgages weren’t really stress tested at all. That’s because most Canadians choose a 5-year fixed rate, so you qualified as long as you could afford the actual payments.

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!

Since then, things have changed. Nowadays, with higher housing prices, and with many borrowers getting gifted down payments from family, housing affordability is a national concern. Interest rates aren’t expected to be ultra-low forever, so you only qualify if you can afford higher payments in future.

Even when interest rates dropped during the pandemic, the Stress Test remained relatively conservative. Here’s a recent look back at how the Bank of Canada Benchmark rate has changed, compared to the average 5-year fixed interest rate for uninsured mortgages.

	Bank of Canada Benchmark interest rate	Average 5-Year Fixed (Uninsured) interest rate
October 25, 2017	4.99%	2.83%
January 17, 2018	5.14%	2.79%
May 9, 2018	5.34%	3.09%
July 10, 2019	5.19%	2.49%
March 18, 2020	5.04%	2.24%
May 20, 2020	4.94%	2.14%
August 12, 2020	4.79%	1.74%
June 1, 2021	5.25%	1.68%

Mortgage Stress Test Example

Sabiha & Hannah want to buy a 2-bedroom condo in Toronto for $716,000 and have 20% down payment saved. They plan to borrow the remaining 80% for a $572,800 mortgage.

They both have great credit and want Nesto’s best 5-year fixed rate of 2.54%. Referring back to our (a) or (b) test, since 5.25% is higher than 2.54% + 2, we’ll use 5.25% to calculate the Stress Test mortgage payment. For a mortgage of $572,800 over 30 years, that’s $3,143/month. (Remember: this is not the actual mortgage payment that Sabiha & Hannah will be making!)

Realtor.ca shows that property taxes are $2,500/year and condo fees are $650/month, including heat. 

Total monthly housing costs are:

   $3,143/month Stress Test mortgage payment

+ $208/month property taxes 🡨 $2,500 / 12 months

+ $325/month condo fees 🡨 50% of $650

+ $0/month heat 🡨 since heat is included in the condo fees, we won’t add it again

_____________

= $3,676/month 

Sabiha works part-time and her T4s from the past 2 years average $20,000/year. Hannah makes $90,000/year as a project manager. Their total household income is $20,000 + $90,000 = $110,000/year, or $9,166/month.

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

$3,676 / $9,166 = 40% 🡨 just over the 39% threshold, which may be too high for some lenders.

However, all hope is not lost! The only debt they have is Hannah’s student loan payment of $200/month, which means their total monthly expenses are: 

   $3,676 total monthly housing costs

+ $200 total monthly debt payments

_____________

= $3,876/month 

Dividing total monthly expenses by monthly household income gives us:

$3,876 / $9,166 = 42.4% 🡨 under the 44% threshold, so it looks like Sabiha & Hannah pass the Stress Test after all!

Final Thoughts

Don’t stress the stress test! It’s there to protect you and provide peace of mind that you’re not borrowing more than you can afford. If you don’t pass, that’s okay – there could be alternatives like adding a co-signer or consolidating monthly debt payments. 

Everyone’s numbers are a little different and each lender uses slightly different policies, so talk to a nesto Advisor to get the right advice for your financial situation. We can help guide you through every step of the mortgage process, plus you always get today’s lowest rates right from the get-go. Click here to get started.

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