What is the mortgage stress test?
All federally regulated banks in Canada are required to perform a mortgage stress test on all prospective borrows. The stress test guidelines are put forth by The Office of the Superintendent of Financial Institutions (OSFI), which is Canada's main financial regulator.
You have to pass the mortgage stress test to get a mortgage with a federally regulated financial institution, such as a bank. The stress test uses a pre-defined interest rate (qualifying rate), to gauge your ability to meet your mortgage payment obligations if interest rates were to increase.
How do I use the stress test calculator?
The stress test calculator requires that you provide information about your mortgage, such as the purchase price, down payment, amortization period, and interest rate (qualifying rate). The qualifying rate used needs to be in accordance with OSFI guidelines.
The stress test also requires you to input your annual income, your projected housing costs, your current debt balances, and any other debt payments you're making each month. As you input your information into the stress test calculator, your results will update automatically.
What's the purpose of the stress test?
The mortgage stress test was introduced on January 1st, 2018, to evaluate if a borrower can withstand interest rate increases on their mortgage. It's a prudent measure implemented by the government to ensure that Canada's housing market stays stable.
The current economic environment has given us some of the lowest mortgage rates on record. Financial regulators know that these low rates won't last forever. And they want to make sure that people taking on mortgages, at these low rates, aren't going to default on their payments if interest rates were to increase.
Is there an actual "test" to the mortgage stress test?
There is no literal "test" that you must take when referring to the mortgage stress test. Instead, the mortgage stress test is a more rigorous set of rules and standards that you must meet to qualify for a mortgage.
These rules and standards are set forth by Financial regulators in Canada. They stipulate that a borrower must meet certain financial standards before a regulated bank can give them a mortgage. The stress test calculator replicates these same standards that a regulated bank will hold you to when evaluating your mortgage application.
Is it mandatory to do a mortgage stress test?
All federally regulated banks are obligated to do a stress test on all mortgage applicants in Canada. This includes the "big 5" banks as well the smaller schedule one banks.
Credit Unions and some other types of lenders aren't required to do a stress test. This is because credit unions are not federally regulated. Despite not being federally regulated, some credit unions still do the mortgage stress test to minimize their own risk.
You'll also find other underregulated mortgage lenders who don't perform stress tests at all. These lenders are not required by law to do so. They're also willing to accept the risk of lending to people who potentially may not be as financially stable. When working with one of these lenders, be mindful that their mortgages usually come with higher interest rates.
Do I have to do a stress test when I renew my mortgage?
If you're renewing your mortgage with the same bank that you already have your mortgage with, then no, you don't have to undergo the mortgage stress test again. If, however, you decide to change banks at renewal time, then the new bank will require you to pass the stress test before they can take you on as a mortgage client.
Keep in mind that Canadian banks must perform a mortgage stress test on all borrowers. Credit unions and other types of mortgage companies are not required by law to perform stress tests, but they might do so anyway.
What interest rate should I use for the stress test?
Canadian banking regulators require mortgage borrowers to pass a stress test using a pre-formulated interest rate, which is also called the qualifying rate. This qualifying interest rate isn't the rate you'll pay on your mortgage but is a hypothetical rate used to stress test the merit of your mortgage application. Use a qualifying interest rate according to the following guidelines:
The qualifying interest rate to use is the greater of the Bank of Canada qualifying rate of 4.94% or the contracted rate you have with your lender + 2%.
For example, if your lender has quoted you an interest rate if 2.95%. The qualifying rate to use for the stress test would be 4.94% because the Bank of Canada qualifying rate of 4.94% is higher than your quoted rate + 2% (2.95% + 2% = 4.95%)
What is the "Qualifying Rate"?
The Bank of Canada qualifying rate is a benchmark interest rate that is used in mortgage stress test calculations. Currently, the qualifying rate is 4.94%.
How is a pass or fail determined in the stress test?
The mortgage stress test takes into consideration the mortgage amount, interest rate, amortization period, income, housing costs, and debt obligations to determine your ability to afford a mortgage. Two debt ratio are used in the stress test, and you must meet a minimum threshold in both ratios to pass the stress test. The ratios are as follows:
Gross Debt Service Ratio (GDS) – GDS measures your ability to afford your mortgage while being able to meet all of your housing costs. Most lenders recommend that no more than 39% of your income should go towards housing costs.
Total Debt Service Ratio (TDS) – TDS measures your ability to afford your mortgage while being able to meet your projected housing costs and existing debt obligations you have. Most lenders recommend that no more than 44% of your income should go towards housing costs and debt obligations.
To pass the stress test and qualify for a mortgage, all applicants must be within the GDS and TDS thresholds set by the lender. The CHMC recommends that GDS and TDS thresholds be set to 35% and 42% respectfully. But given a mortgage applicant's credit history, lenders are free to adjust the GDS and TDS thresholds within a reasonable range.
How can I pass the stress test?
Specific steps can be taken to improve your chances of passing the mortgage stress test. The highest levered options are:
- Increasing your down payment – By increasing your down payment, you will decrease your mortgage payments, which will help to lower your housing costs.
- Increasing your income – By increasing your income, you improve your ability to afford a larger mortgage and meet your housing costs and debt obligations. Not everyone is in a position to increase their incomes overnight. It takes time. But if you're planning on getting a mortgage in the next year or two, you can begin to take the necessary steps to increase your income, like asking for a raise or changing jobs.
- Reducing your debt obligations – By paying off or reducing your outstanding debt balances, you will decrease your debt burden, which will improve your TDS ratio. When paying down your debt, focus on paying down your highest interest debts first, like your credit cards. Also, consider consolidating your debts by using a lower interest borrowing source to pay off your high-interest debt.
- Apply with a co-applicant – You can increase your chances of passing the stress test by applying for a mortgage with a co-applicant. The co-applicant can help improve the overall income levels used in the stress test. You can use your spouse, partner, or family member as a co-applicant on a mortgage. Some lenders have also started to introduce shared equity mortgages, where you can apply for a mortgage with a broader group of friends and family members.
What if I can't pass the mortgage stress test?
Whether it's not being able to get your first mortgage or not being able to renew your current mortgage, the possibility of not passing the mortgage stress test is a concern for many Canadians.
If not being able to meet the requirements of the mortgage stress test is holding you back from getting a mortgage, there are other avenues you can explore.
- Credit unions - You may be able to skip the mortgage stress test by going with a credit union. Credit unions are not required to do stress tests since they're not regulated at the federal level.
- Mortgage finance companies - Unlike banks and credit unions, mortgage finance companies (or monoline mortgage lenders) only specialize in mortgages. Furthermore, they aren't all required to do stress tests from a regulatory standpoint.
- Buy a more affordable property - You may not be able to pass the stress test because you may be financially overextending yourself. Consider buying a home in a more affordable real estate market.
- Private lenders - If you're having significant difficulties getting a mortgage, some private lenders may be willing to lend you the funds to finance your purchase. However, be wary that private lenders will charge very high-interest rates with shorter payback terms.
- Talk to a mortgage broker - Not everyone can qualify for a mortgage, but a good mortgage broker may be able to help you find a mortgage given your current circumstances.