What's the mortgage stress test?
The mortgage stress test doesn’t have to get between you and your dream home.
Learn all about how the test works, what it means for home buyers, and how Meridian can help.
In January 2018, the federal government introduced new mortgage rules that impact how Canadians qualify for mortgages from federally regulated banks. One of the new additions that some people find a bit confusing is the requirement that all Canadian home buyers pass a mortgage “stress test.” Don’t stress out! We’ll explain.
The stress test is a calculation that answers this question: Could you still afford to pay your mortgage if interest rates went up?
This is important because the economy is always changing and interest rates are bound to move up and down. The stress test makes sure that you can still make your mortgage payments even if interest rates go up. Your stress test results determine whether you qualify for the mortgage you want. The stress test applies to all homebuyers, even when they are making a 20% down payment.
Did you know? Meridian’s different
As a credit union, we’re more flexible than banks when it comes to approving mortgages.
How does the stress test work?
When you apply for a conventional mortgage, one that doesn’t need mortgage loan insurance, the bank must use the higher of these 2 options to determine if you qualify:
The posted Bank of Canada Qualifying Rate (currently 5.25%)
or
The rate your bank is offering + 2%
So let's do the math
Say you are applying to borrow $400,000 and the bank is offering you 5.49%. The stress test rate (bank rate + 2%) is 7.49%, which is lower than the posted Bank of Canada rate.
Passing the stress test means that you need to prove you could make mortgage payments for the higher rate (7.49% ), which would be about $2,924 per month. Your payment for the 5.49% mortgage offer would actually be around $2,439, but the bank needs to know that you can still handle your mortgage if rates go up.
When you apply for a mortgage that requires mortgage loan insurance, like a high ratio mortgage, the bank uses the higher of the Bank of Canada rate or the offered rate for the stress test to determine if you qualify.
So how does the bank figure out how much I can afford?
To calculate how much mortgage you can afford, the bank focuses on your total income, your housing costs, and any debt you have. This is what they’re generally looking for:
- Your housing costs (mortgage, property tax, heat, etc.) make up less than 39% of your pre-tax income. This is your GDS (Gross Debt Service Ratio).
- The total of your housing costs plus any debt payments you have makes up less than 44% of your pre-tax income. This is your TDS (Total Debt Service Ratio) – sometimes called your “total debt load.”
Want to do the math again?
Take the mortgage payment we calculated for the stress test – $2,924 per month. Add your other housing costs – let’s say $350 per month for property taxes and your hydro bill. You also have car loan and line of credit payments of $660 per month.
$2,404 + $350 + $660 = $3,934 (total debt load)
Now, your total debt load shouldn’t exceed 44% of your pre-tax income, so you would need a monthly income of about $8,940 (around $107,280 annually).
How does the stress test affect me?
Benefits
The stress test helps make sure you don’t find yourself in a bad situation if interest rates change dramatically before the end of your mortgage term. It also gives financial institutions more peace of mind when it comes to lending out money.
Drawbacks
One of the common criticisms of the stress test is that it can make it harder for first time home buyers because they need to have more money for a down payment or a higher income in order to qualify.
People renewing their mortgage often find themselves in an odd position as well, because if they switch lenders they have to pass the stress test – even if they got their mortgage before January 2018, when the stress test was introduced. So some people stay with a lender they aren’t happy with simply because they can’t pass the stress test.
How does Meridian use the stress test?
We use the stress test to help evaluate whether a mortgage is a good fit for you. We don’t want you to take out a mortgage that you can’t actually afford.
However, we don’t disqualify people for mortgages based solely on the results of the stress test. As a provincially regulated financial institution, we have more flexibility when it comes to the mortgages we offer and approve. The stress test is a great way to evaluate risk, but there are factors it doesn’t take into account, like income appreciation, accelerated payment options, and overall principal reduction. We work hard to find flexible solutions to help you afford your dream home even if you don’t pass the stress test.