It doesn’t matter if you’re a first-time homebuyer or a seasoned veteran of Canada’s housing market. Whether you’re applying for a mortgage or currently have one, you’ll want to have a good understanding of the mortgage stress test rules.
The relatively new test was implemented in 2018, and it’s already seen some changes since then that Canadians should be aware of as they look into mortgages for 2022 and beyond.
If you don’t know much about the mortgage stress test, that’s okay—we’ve got you covered.
Keep scrolling to learn all about:
- What precisely the mortgage stress test is
- How the mortgage stress test works
- The minimum qualifying rate
- How the stress test determines what you can afford
- How the mortgage stress test affects Canadians
- How to improve your stress test results
- And if it’s possible to get around the stress test
What is the mortgage stress test?
Don’t worry; there’s no need to study for this test.
The mortgage stress test is just a set of federally mandated rules that mortgage providers must use to determine if you qualify for a mortgage to calculate how much you’re eligible to borrow.
The stress test is used when you:
- Apply for a new mortgage
- Switch mortgages
- Take out a homeowner line of credit
- Refinance your mortgage
How does the mortgage stress test work?
Now that you know what a mortgage stress test is, let’s take a look at how it works.
When applying for a mortgage, the provider will offer you a contract interest rate.. You would think that this is the interest rate they would use to determine if you qualify for the mortgage, but that’s not the case. Instead, the provider will calculate if you’re eligible for the mortgage by using a significantly higher interest rate –– this is called the minimum qualifying rate.
The reason they do this is to ensure that you’ll be able to make your payments when interest rates rise or something unexpected happens, like the loss of a job. Hence the “stress” in stress test.
What is the minimum qualifying rate?
Before telling you what the minimum qualifying rate is, we’ll first tell you what it’s not.
The minimum qualifying rate is not the contract interest rate that you will actually have to pay as part of your mortgage. It’s the significantly higher rate (as mentioned above) that is used as part of the mortgage stress test.
The way that your minimum qualifying rate is determined is by using the greater of either:
- The benchmark rate of 5.25%
- Your contract interest rate, plus an additional 2%
For example, let’s say, based on your credit score, 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%).
Now, let’s take a quick look at how using the minimum qualifying rate affects what you’re able to afford.
Let’s say your mortgage provider is offering you a contract interest rate of 2.5% to borrow $500,000. At this rate, you would need to be able to afford $2,240/ month. However, that is not the rate that the mortgage stress test will use –– it uses the minimum qualifying rate of 5.25%, which means that you would have to show that you’re able to afford a much higher monthly payment of $2,980.
How does the mortgage stress test determine what I can afford?
When conducting a mortgage stress test to determine what you’re able to afford, lenders use a few key metrics to determine if you can pass the test, including these two calculations:
- Gross debt service (GDS) ratio
- Total debt service (TDS) ratio
GDS ratio: the percentage of your pre-tax income that will go toward paying for your housing costs. These costs include your mortgage, property taxes, heat, and 50% of the condo fees if applicable. Lenders generally want to see that the GDS ratio does not exceed 39%. However, if you have good credit and a steady income, your mortgage provider may allow for a slightly higher GDS ratio.
TDS ratio: 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 the banks. Just like the GDS ratio, your mortgage provider may allow a slightly higher TDS ratio depending on your credit score and job stability.
It’s important to 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 what the expense would be if the minimum qualifying rate were used.
Besides the stress test, there is another significant factor that you have to keep in mind when determining how much you can afford on a house: the minimum down payment amount.
Here’s the minimum down payment required depending on the purchase price of your home:
So, even if your GDS and TDS ratios would qualify you for a mortgage, you would still be required to pay the correct down payment.
How does the stress test affect me?
The benefit of the mortgage stress test is that it helps to ensure that you will still be able to pay your mortgage even if interest rates rise or other unforeseen events occur that affect your finances. All of that is great, but the mortgage stress test also comes with drawbacks.
Because the stress test uses the minimum qualifying rate to determine your mortgage eligibility and amount, you’re not able to borrow nearly as much as you otherwise would be able to if your actual contract interest rate were used.
Limiting the amount that you can borrow can impact the type of property you can afford –– you may have to switch gears and start looking 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 mortgage stress test can affect your ability to switch lenders, refinance your mortgage, or take out a homeowner’s line of credit.
What can I do to improve my mortgage stress test results?
The stress test can seem quite daunting when first learning about it, but luckily there are a few things that you can work toward to help make the stress test an easy “pass.”
Here are the factors that can help:
- Put down a larger down payment to decrease your monthly mortgage expense
- Work to pay off your debt before applying for a mortgage
- Wait until your salary is higher to increase your household income
Doing any of these things can help improve the stress test’s TDS and GDS ratios –– doing all three is bound to increase the chances of passing the stress test drastically.
Can I get around the stress test?
If you’re using a federally regulated lender like the big banks, or your mortgage is insured, there is no way to get around the mortgage stress test.
However, if your mortgage is uninsured and you opt to go with a lender that is provincially regulated, such as a credit union instead, then the stress test is not needed.
That being said, doing this comes at a cost.
Using this type of mortgage provider will allow you to forgo the stress test at the minimum qualifying rate of 5.25%. Instead, they may allow you to qualify at a lower rate. 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. This means you’re paying a premium for the ability to use a lower minimum qualifying rate.
Navigating The Mortgage Stress Test With Pineapple
At Pineapple, we see the market from a holistic point of view, partnering with multiple lenders (including the big banks) in order to provide exceptional service and find the best rates for our clients. Our experienced mortgage agents operate with a high level of knowledge and integrity, making it their mission to ensure you find the mortgage that best fits your needs so that you can enter homeownership empowered and confident.
For more information and resources on the mortgage stress test and securing your mortgage, visit our Homebuyers page or get in touch with a Pineapple mortgage agent.