What is the mortgage stress test?
The test was designed to cool an overheated housing market of the time by making sure borrowers would be able to pay back their loans if rates were to suddenly rise.
The goal is to make sure people are buying affordable homes to prevent housing market issues.
Even if a borrower could get a mortgage at, for example, three per cent, that person’s lender was obligated to crunch the numbers as though the rate was higher — at around five per cent, for example — to make sure the loan wouldn’t be too onerous for the borrower to pay back at their income level if rates were to suddenly rise. If the borrower failed the test at the higher rate, the lender wasn’t allowed to lend to them, even if they wanted to.
That testing rate has already been lowered twice since mid-March (2020) when it dropped 15 points from 5.19 per cent to 5.04, and then again in May when it dropped another 10 points to 4.94 per cent.
Banks determine a maximum monthly mortgage payment based on a percentage of your monthly income. In the past, they would calculate these payments using the mortgage rate you qualified for based on your credit score. Now, they calculate these payments using the Bank of Canada’s five-year benchmark rate or your contractual rate plus two per cent. Even though you won’t actually be paying that higher rate, using it to determine affordability means you must borrow less money.
To pass the stress test, you need to balance the equation by either borrowing less money or increasing your income. There are a few tricks you can employ to get the home you want under the new stress test.
Pay Down Your Debts
The amount lenders say you can afford is partially based on the total debt service (TDS) ratio. They want your total monthly payments – including mortgage, car loans, student loans, and credit card payments – to be less than 42 per cent. When you decrease debt payments, you increase the amount you can put toward the mortgage.
For instance, the bank might allow a couple earning a combined monthly salary of $8,000 to have a TDS of $3,360. If that couple had a $500 car payment, $500 monthly minimum on credit card payments, and $250 per month for student loans, that would only leave $2,110 available for a mortgage payment. Getting rid of the credit card debt would mean the couple could take out a mortgage with a $2,610 monthly payment.
Make a Bigger Down Payment
You might qualify for a lower mortgage than you’d hoped for, but this doesn’t necessarily mean you have to settle for a cheaper home. If you increase the amount of money you put toward the down payment, you decrease the amount you need to borrow.
For instance, let’s say the home of your dreams costs $400,000. You have the $20,000 you need for a five per cent down payment, but the new stress test means you can only take out a $350,000 mortgage. By putting an extra $30,000 into your down payment, you can get the home you want with the mortgage the lender says you can get. Consider borrowing from your RRSP if it would otherwise be hard to save up $30,000 in cash.
Research Property Tax Rates
The mortgage payment the bank says you can afford includes things like property taxes and homeowners’ insurance. If the location you were thinking about has high property tax rates, they might put your mortgage out of reach. By building the exact same home in a different location, you could save $100 or more each month. This allows many families to pass the stress test.
Move Further Out in the Suburbs
The old real estate adage has us believing it’s all about location, location, location. For some people though, the right home is more about the home itself than where it’s located. If you’ve found a home style you love, but are having a hard time passing the stress test based on the community you selected, consider how much money you could save if you built that same home a bit further from the city. Many “bedroom communities” like Spruce Grove or Fort Saskatchewan have the same types of amenities you’d find closer to the downtown area, with only a slightly longer commute.
Check Out Credit Unions
Credit unions must follow provincial laws, not federal, so you can sometimes qualify for a larger mortgage with a credit union than you can with a traditional bank. You don’t have to pass the federal stress test. The downside is credit unions may not offer mortgages for new construction homes. They may also not be as familiar with the new construction lending process as other banks, or the builder’s preferred lender. However, this solution may be the right one for you.
The new stress test doesn’t mean you can’t get a quality home at a price you can afford. By tweaking some aspects of the home buying process, you’ll be able to find a home that fits your wants, needs and budget.