The New Mortgage Stress Test: How Will It Affect You?

As if buying a home wasn’t stressful enough. Now there’s a test you need to pass before you get approved for a mortgage?

Yes, it’s true.

But don’t fret—it’s not a conventional sit down and grab your pencil kind of test. And it’s actually meant to benefit you in the future, even if it doesn’t feel that way right now.

Read on to learn more about the mortgage stress test, what it means to you, and why you should care.

What Is the Mortgage Stress Test?

In the financial world, a stress test is used to prepare potential clients for the worst-case scenario.

So, what does this mean in terms of buying a home?

Anyone applying for or renewing a mortgage will need to undergo a series of questions meant to put the applicant in an imagined worst-case financial scenario to ensure that under changing circumstances, they can still make their monthly mortgage payment.

Essentially, the stress test forces you to consider the things you don’t want to think about when applying for a mortgage—rising interest rates, loss of employment, financial turmoil, and the high costs of being a homeowner.

Does Everyone Need to Pass the Stress Test to Get Approved?

Yes. Even people with the most solid credit and a full down payment will need to pass the test. New applicants and established borrowers who want to switch lenders as soon as their current term ends aren’t excluded either.

Prior to January 1, 2018, the stress test applied only to those who didn’t have their 20% down payment (high-ratio mortgages) and to those who took out less than a 5-year term.

So, what’s changed?

Not only who it applies to but also the current calculation rate being used to determine if someone qualifies for a mortgage. The determining rate started out being calculated at 4.79% and just recently jumped to 5.25% effective June 1, 2021.

How Does the Mortgage Stress Test Work?

Typically, when applying for a loan, your bank would offer you an interest rate based on your credit score. It doesn’t work this way with the mortgage stress test—instead, there are two calculations made using two different rates:

1. The best mortgage rate available plus 2% (this would be your contracted rate)
2. 5.25% (the new Bank of Canada qualifying rate)

Your stress test payments are calculated at 5.25% (which is a considerably higher rate) to make sure you’d still be able to afford them if your rates were to rise during your term or a negative change to your financial situation occurs.

But that’s not all.

They’ll also look at your gross debt service ratio (GDS) and your total debt service ratio (TDS) to determine how much more you can afford in terms of taking out a mortgage.

Your gross debt service ratio is the monthly expenses that come with owning a home like:

• Utility bills
• Property taxes
• Condo fees (if applicable)

The total of these expenses should be no higher than 32% of your monthly income.

Your total debt service ratio covers all the other monthly debts you may have:

• Vehicle payments
• Personal and student loans
• Credit card and line of credit balances

The total of these expenses should be no higher than 42% of your gross monthly income.

How Will the Mortgage Stress Test Affect Me?

The mortgage stress test has been legally required in Canada since 2018. It was put into place to protect borrowers from the possibility of defaulting on their payments and potentially losing their homes if and when interest rates rise.

The higher qualifying rate actually restricts how much you can spend on a home as it reduces the amount of mortgage you’re approved for. This can be troublesome for current homeowners who are looking to refinance or renew their mortgages.

If you meet the qualifications to get a mortgage loan at 1.78% (let’s say this is the best contracted rate available at the time of application), you would then still need to prove that you could make your payments if interest rates suddenly jumped to 5.25%.

On a $400,000 loan, 1.78% would make your monthly payments approximately $1650.00. Great! You can handle that, no problem!

But wait. The interest rates have now climbed to 5.25% and your monthly payment has jumped to a whopping $2385.00. Suddenly, this isn’t so enticing. Nor is it feasible. This is what the banks want to protect you from. This is why the stress test was put into place.

Here’s what you need to know: Even if you qualify for the best rate possible at 1.78%, but don’t qualify for the worst-case scenario at 5.25%, you won’t pass the stress test and will be turned down for the loan.

The Hard Truth About the Mortgage Stress Test

The stress test makes qualifying for a mortgage a little more difficult, but if you keep in mind that it’s put into place as a means of protecting your future, it doesn’t seem so bad after all.

Think of the heartache and disappointment you’d feel if you suddenly needed to sell your home because you couldn’t afford the rising cost of its payments?

So, what can you do to prepare for the test? Pay down as much debt as possible beforehand. Save for a bigger down payment. Be realistic when looking at homes and only apply for what you can afford.