Everything You Need to Know About the Mortgage Stress Test
It doesn’t matter if you’re a first-time homebuyer or an experienced buyer. Whether you’re applying for a mortgage or have one, having a good understanding of the mortgage stress test rules can help you make better financial decisions.
The relatively new stress test was implemented in 2018 and it has already undergone some changes that Canadians should be aware of as they look into mortgages for 2022 and beyond.
If you’re not familiar with the mortgage stress test, don’t worry—we can help.
What is the mortgage street test?
The mortgage stress test is a federally mandated set of rules that mortgage providers must use to determine if clients qualify for a mortgage.
So, when is the stress test used?
Apply for a new mortgage
Take out a homeowner line of credit
Refinance your mortgage
How exactly does the mortgage stress test work?
Now that you have some background information on mortgage stress tests, let’s look at how they work.
When you apply for a mortgage, the lender will offer you a contract interest rate—the rate they will use to determine if you qualify for the mortgage. But that’s not the only rate that matters.
The lender will also calculate if you’re eligible for the mortgage by using a significantly higher interest rate—this is called the minimum qualifying rate.
To make sure you can continue to pay off your debt, creditors often ask you to prove that you could do so even if interest rates rise or something unexpected happens, like the loss of a job.
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.
I’m not happy with my stress test result. What can I do to improve it?
When I first learned about the stress test, it seemed quite daunting. However, there are a few things you can work toward to help make the stress test a breeze.
Taking these steps can help:
Put down a larger down payment and you will pay less each month.
If you have debt, pay that off before applying for a mortgage.
Wait until you can afford it before increasing your household income.
Do any of these things to improve the TDS and GDS ratios of a stress test –– do all three and you’ll be far more likely to pass the stress test.
Is there any way around the mortgage stress test?
If you’re using a federally regulated lender like a big bank or your mortgage is insured, you won’t be able to get around a stress test.
If you choose to borrow money from a provincially regulated lender such as a credit union, the stress test is not needed. However, doing this comes with some drawbacks.
Some mortgage providers will allow you to take advantage of a lower qualifying rate, called the Bankers’ Acceptance Mortgage Rate (BAMR), when you buy a home. This lower qualifying rate will benefit you by allowing you to borrow more at this rate but this will also be your actual contracted rate –– this could be much higher than the rates provided by the federally mandated mortgage providers today.
At AskAHmad.ca and the Total Mortgage 360 Team we partner with multiple lenders (including the big banks) to find the best rates for our clients. Our experienced mortgage brokers and agents operate with a high level of knowledge and integrity, making it our mission to ensure you find the mortgage that best fits your needs so that you can enter homeownership empowered and confident.
How can Ahmad, mortgage specialist at AskAhmad.ca and the Total Mortgage Source 360 Team help you?
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We can offer you some of the most competitive interest rates and mortgage products available because we have access to Canada’s leading lenders, including banks, mortgage firms, trust companies and private lenders.
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