If you currently have a mortgage or you’re looking to become a homeowner, you’ve likely heard the phrase “stress test”, as it’s notoriously linked to mortgage qualification these days. A stress test is the act of using a fictitious, higher interest rate to illustrate a borrower’s repayment ability in the event that interest rates rise quickly.
On January 1st, 2018, homebuyers and those who were looking to renew/refinance their current mortgage – all had to pass the newly introduced stress test to qualify for their desired mortgage amounts. Previously, only borrowers who had less than a 20% down payment (high-ratio mortgage borrowers) were subject to a stress test.
To the disappointment of many, but not all, stress testing seems to be here to stay and has been enhanced as of June 1st, 2021 with a new qualifying rate being the greater of either 5.25%, or the approval contract rate plus 2%. Prior to June 1st, the qualifying rate was 4.79%, or the approval contract rate plus 2%.
Mortgage Stress Test 2.0 Rules
The government is responsible for maintaining a safe and affordable housing market. While prices may appear to be running away in the short term, there is also the fact that many Canadian’s wealth rests within this market and this decision was a tiny step towards assessing market reaction to further regulation. Otherwise we believe that supply would have been addressed more urgently.
This minor adjustment to the stress test represents an approx. 4% reduction of borrowing power, which is symbolic to show “action” without being responsible for triggering anything that could be deemed catastrophic. In other words, they are acknowledging the problem by addressing demand by limited action, purposefully. While we applaud this step, we are eager to see more action towards the supply side of the equation.
What’s stress testing?
All mortgage applications in Canada are subject to stress testing using the higher rate between the new qualifying rate set by the Bank of Canada, or the contractual mortgage rate +2%.
(eg, 5-year fixed rate at 3.59% +2% = 5.59%).
This means that in most cases, a borrower now qualifies for approximately 4% less money to put towards your home purchase or the amount of equity you can access through a refinance.
The only exceptions are if you have a legally binding purchase and sale agreement dated prior to June 1st 2021, or if you are renewing an existing mortgage that default insured. In the example of an accepted offer dated prior to June 1st, a borrower would be subject to the greater of the previous Stress Test rate of 4.79%, or the contract rate +2%. In the example of an insured mortgage coming due for renewal, the qualifying rules applied would be based on the date that the insured amount was funded.
The Bank of Canada had begun to consistently raise its key rate prior to COVID and would have likely continued to do so if not for the required pandemic measures. While they always have this lever to pull in order to influence the mortgage market, any decisions made will impact the rest of the Canadian economy. We believe that the Government will hesitate to influence the prime borrowing rate until they assess the impact of the new stress test.
With fewer people qualifying for homes thanks to stress testing, the government’s banking on demand falling, bringing prices down with them. Only time will tell if the intended results will prove true in housing markets across the country.
The COVID environment, the stress test, and slightly increasing interest rates has many borrowers – particularly first-time buyers – home shopping outside of major cities and towards rural areas, in the hopes of finding a place to call home that still falls within their means. This growing trend of leaving the major cities has caused some rural cottage regions to see price increases nearing 100% and has welcomed a new list of concerns for lenders and regulators alike that will dive into within another article.
This straightforward math will help you stress test
In simplified terms, before the new qualification rules came into effect, if you had a down payment of 20% or higher and a 25-year amortization, your monthly mortgage payments were roughly $500 for every $100,000 in mortgage debt.
Currently, you’ll have to qualify as if your payments are $600 for every $100,000 worth of mortgage you hold.
What it comes down to, therefore, is whether you can afford to pay an extra $100 a month for every $100,000 of mortgage debt you take on.
This is also a useful payment tolerance test in an environment where mortgage interest rates are rising like they are today.
Look into renewal options early
Since you can expect to qualify for a mortgage at a higher rate these days, it’s wise to review your renewal options well in advance of your maturity date in order to ensure you have time to make adjustments, as needed.
Do you have questions about mortgage qualification, or your mortgage in general? Answers are a call or email away with one of our commission-free advisor.