What is the minimum qualifying rate?

Before we tell you what the minimum qualifying rate is, let’s make sure we’re clear on what it isn’t. The minimum qualifying rate is not the rate at which you will actually pay as part of your mortgage. Instead, it’s the higher interest rate that is used as part of the stress test used in mortgage approvals.

Your minimum qualifying rate is determined is by using the greater of either:

The benchmark rate of 5.25% or, Your contract interest rate, plus an additional 2%

Let’s say you have a credit score of 750 and your mortgage provider offers you a contract interest rate of 2.5%. Your minimum qualifying rate would be 5.25%, as it’s higher than 4.5% (2.5% contract interest rate +2%).

Let’s look at how using the minimum qualifying rate affects what you can afford.

If your mortgage provider is offering you a contract interest rate of 2.5% to borrow $500,000, you would need to be able to afford $2,240/month. However, if you apply for a mortgage under the Bank of Canada’s new mortgage stress test rules, that rate will drop by more than half (to 5.25%), which means that you’ll have to show that you can afford a much higher monthly payment of $2,980.

This is how the mortgage stress test determines what you can actually afford!

When you apply for a mortgage, the lender will run a stress test to determine if you can afford the home. The lender uses two calculations to accomplish this:

GDS: Gross Debt Service Ratio

TDS: Total Debt Service Ratio 

GDS Ratio:  Your GDS ratio is the percentage of your pre-tax income that will go toward paying for housing costs such as mortgage payments, property taxes, heat, and condo fees. Lenders generally want to see that the GDS ratio does not exceed 39 percent. However, if you have good credit and a steady income, your mortgage provider may allow for a slightly higher GDS ratio.

TDS Ratio:  The total debt service ratio is the percentage of your pre-tax income that goes toward all of your outstanding personal debt. These debts include your mortgage, lines of credit, credit cards, car loans, etc. The TDS ratio should be no more than 44%, to qualify with prime lenders such as banks and credit unions. Just like with the GDS ratio, your lender may allow a slightly higher TDS ratio depending on your credit score or job stability.

Note that the mortgage payment expense used to calculate the above ratios is not your actual mortgage expense calculated using your contract interest rate. Instead, it’s a hypothetical expense based on a required minimum qualifying rate.

In addition to the stress test, another factor you should keep in mind when determining how much you can afford on a house is the minimum down payment amount.

Here’s the minimum down payment you’ll need depending on the purchase price of your home:

500K or Less: 5% Downpayment

500K to 999K: 5% for the first 500K, 10% for the remaining balance

1,000,000 or more: 20% Down Payment 

So, even if your GDS and TDS ratios qualify you for a mortgage, you still have to make a down payment.

How will the stress test affect my qualification?

The stress test helps ensure that you’ll be able to keep up with your mortgage if interest rates rise or other unforeseen events occur. The tests have their drawbacks, though.

Because the stress test uses your minimum qualifying rate to determine your mortgage eligibility and amount, you will be able to borrow less than you otherwise could have if your actual contract interest rate were used.

Limiting the amount that you can borrow can impact the type of home you can afford—you may have to switch gears and look at townhomes or condos instead of the detached home you originally wanted. This can also impact where you can afford to buy a home. This doesn’t just affect new buyers—the stress test affects your ability to switch lenders, refinance your mortgage, or take out a line of credit.