Even 1 year after the latest changes to the mortgage stress test rules, there is still a lot of confusion surrounding the stress test and its effects. That’s why we put together this infographic to help you understand just exactly what the mortgage stress test is and how it affects your affordability.
When you apply for a mortgage, you have to prove to the lender that you can afford your mortgage if rates go up – and they are.
The latest version of Guideline B-20 (as the stress test is officially called) took effect on January 1, 2018. This version required all borrowers to qualify at a higher rate. Before 2018, only borrowers that had less than 20% down had to pass the stress test.
Canadians are some of the most indebted people in the world, and until recently, our interest rates were among the lowest for developed nations. That means we had a lot of cheap debt, so it was easy to pay for.
The Canadian government knew that interest rates couldn’t stay low forever, and when they rose, those with a lot of debt would be in serious trouble.
The only institutions that must abide by the stress test are federally-regulated financial institutions. That includes banks and monoline lenders.
Credit unions are provincially regulated, and therefore don’t have to apply the stress test to their mortgages. This hasn’t stopped a few from implementing tests of their own, however. Some credit unions believe that a stress test is a good practice to follow. They may have different values for the stress test that are lower than the federal one.
Private lenders are also provincially regulated, and can choose whether or not to stress test their applicants. Not all private lenders are shady individuals that make backroom deals, but with higher interest rates and no stress testing it can be easier to fall into debt – remember to do your homework!
As a federal regulation, the stress test applies in all provinces in territories.
It’s fine to know what the stress test is, but it’s more important to know how it will affect you. No worries, I’ve got you covered.
The first thing to note about the stress test is that it doesn’t affect what your actual mortgage payment will be.
The second thing to note is that the mortgage stress test negatively affects your home affordability 100% of the time. The higher your interest rate is, the less you can afford because your monthly payment takes up a larger percentage of your monthly income.
The easiest way to see how the stress test affects you is to use the government of Canada’s online mortgage stress test calculator.
If you want to calculate your home affordability manually, it’s not hard. It should only take a few minutes.
First you have to know how big your down payment will be. It’s easy if you’re not currently a homeowner and aren’t relying on the sale of your current home to be the down payment on your next one.
Round up all the money you’ve been saving in your savings account, TFSA, or RRSP (if you’re a first-time homebuyer) and any gifts you may receive from family. As a first-time homebuyer you can use the Home Buyers’ Plan to use RRSP money as a down payment – this may not always be the best idea, as it could be a net zero benefit for you and you lose out on any gains you might have made.
Down payments in Canada must be at least 5% of the purchase price for homes valued under $500,000. If the home is worth more than $500,000, the minimum down payment is
$25,000 + 10% of the value over $500,000
So a quick way to estimate your max purchase price is to divide your down payment by 5% (0.05).
If you have $15,000 for a down payment, your home’s purchase price can be no more than $300,000. Keep in mind that this does not completely reflect your real affordability. Higher down payments mean lower monthly payments, which in turn mean higher affordability.
The next step is to calculate your monthly income. This is easy if you are salaried – just take your annual income and divide it by 12.
If you’re paid hourly, then it’s only a little harder. If you’ve been working for a year or more at your current job, then you already know what you made on average for the previous year, so just divide that number by 12.
If you’re self-employed with highly irregular income, then it becomes a lot harder to estimate your income, especially if you have the potential for growth. In that case, you may want to speak to a mortgage broker who can help structure your file.
Since your monthly housing costs shouldn’t be more than 39% of your income, multiply your income by 39% to see how much you should be spending – it’s that simple.
If you make $5,000 per month, your housing should cost no more than
$5,000 × 39% = $1,950
Remember that GDS includes heating and property taxes. If we estimate heating to be $150 and property taxes to be $200 that leaves us with $1,600 left for a mortgage payment.
If we use that $15,000 down payment from earlier, we know that $300,000 is the MAX we might afford. Can $1,600 afford that?
Yes, it can! With $15,000 down on a $300,000 mortgage at 2.85%, your monthly payments would be $1,380.
Don’t forget that you have to qualify at either 2 percentage points higher than your contracted rate, or the benchmark rate (currently at 5.34%).
Since 2% + 2.85% is lower than the benchmark rate, you have to qualify at 5.34%. The monthly payment on the same mortgage at the higher interest rate would be $1,782 – higher than the $1,600 we could afford.
That means with a monthly income of $5,000 you will probably not be approved for a mortgage to buy a $300,000 house with $15,000.
Let’s find a number that works, then. At a rate of 5.34%, a $1,600 monthly payment means you can purchase a house worth $269,000. You affordability decreased by 10% in this case even though your finances are the same!
Double check your TDS
Next you have to know how much you’re spending per month on all your debts. Having more debt means you can afford to spend less per month, obviously. Write that number down. For example, if you have a car loan of $300/month and a student loan payment of $200/month, your total debt is $500/month.
Your max TDS is 44% of your income, which is that mortgage payment from earlier + your monthly debt payment. In this case, it’s $1,600 + $500, or $2,100. Multiply your income by 44% and see if it’s higher or lower than that number.
$5,000 x 44% = $2,200
Since $2,100 is lower than $2,200, your TDS is good!
You may have heard from your current lender that you won’t have to pass the stress test so long as you stay with them.
That’s true – the stress test doesn’t apply when renewing your existing mortgage at the same institution. You would have to pass the stress test if you wanted to switch lenders, however.
Some may feel as though they are stuck with their current lender because of this, which is exactly what they want you to think. That way, they can offer less-than-favourable interest rates on renewal with the confidence that you won’t shop elsewhere.
But you may still be able to pass the stress test at another lender!
Keep in mind that the balance owning on your mortgage will be lower than it was when you started your mortgage term – unless you took out equity with a home equity loan or home equity line of credit.
When you apply for a renewal, you need to finance less money than before. This is similar to saving up a larger down payment – it improves your affordability!
It doesn’t hurt to ask a mortgage broker if you are able to switch lenders at renewal for a better rate. The worst they can say is “No,” and that leaves you in the same position as if you hadn’t asked at all.
If you don’t qualify for a mortgage at the bank, all isn’t lost.
The first thing you should do is see if you can find a better mortgage rate. The qualifying rate is 2 percentage points higher than your contracted rate or 5.34%, whichever is higher. If the mortgage you’re applying for is 3.44% or higher, you may be able to pass the stress test by bringing it down to the benchmark.
If you’re already at the benchmark rate and still didn’t qualify, there are still options.
The first thing you should do is talk to a mortgage broker that works with provincially-regulated financial institutions, such as credit unions. Because credit unions can set their own rules for stress tests, you may be tested at a much lower rate than 5.34%, or not at all.
If you still can’t get a mortgage at a credit union, you may have to adjust your housing expectations. You can be denied for a $400,000 mortgage but could be approved for a $350,000. That would still let you buy a home, even if it isn’t the one you initially hoped for.