The New Mortgage Stress Test Changes – June 1 2021

By Robin Tuck
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If you’ve been playing close attention to the housing market recently, or if you’re working on purchasing a house, you’ll probably have heard that lending institutions across Canada have recently raised their stress test from 4.79% to 5.25%. This blog post is going to explore what that means, who it applies to and how it will affect your ability to afford a new home. It will also touch on what that might mean for the housing market demand going forwards.

What is the stress test?

If the stress test means nothing to you yet, don’t worry, you’re not alone, but it is definitely something you’ll need to be aware of as you look to purchase a new property. This was a new metric introduced in 2017 by the Canadian Government to help reduce the number of mortgage defaulters in Canada. If the last time you purchased a property was prior to 2017, this might be brand new information for you!

The stress test is a key metric that banks use to qualify you for a mortgage, and it’s really quite straightforward.

Simply put, the bank knows you can afford your payments today at 1.78% interest, but would you still be able to afford them if the interest rates rose to 5.25%? This is basically the bank’s way of weeding out potential defaulters in the future when the interest rates inevitably go up.

Whereas before, the hypothetical payments you’d have to afford were based on 4.79%, they’re now based on 5.25%.

How is the stress test determined?

The mortgage stress test is determined in the following way. It is the higher of:

  • The rate offered by your lender plus 2%; or
  • 5.25% (up from 4.79% prior to June 1)

This basically means if you qualify for a mortgage that’s lower than 3.25%, you’ll be subject to the 5.25% stress test, but if you qualify for something above 3.25%, you’ll have to add 2% to whatever your rate is.

But why is the stress test necessary? I’m locked in for the next 5 years!

You may be locked in at your current rate for the next 3, 5 or even 7 years, but when it’s time to renew your mortgage, it’s very likely that you could be renewed at a much higher interest rate (because there’s really only one direction rates can go from here!). Testing you today on a higher interest rate will potentially also save you a lot of headaches down the road too if that higher interest rate is something you might not be able to cover!

How will the stress test changes affect me?

The easiest way to show you how you’ll be affected is to look at an example. Let’s say you were looking at a house for $500k, and that prior to the June 1 change, you were pre-qualified for exactly this amount.

Assuming you were going to put down 20%, you’d have needed $400k of financing.

Now, enter the new stress test requirements.

Let’s assume your interest rate was 1.78%, and based on that, your payments today will be approximately $1,650 per month.

Under the previous stress test rules, they would have seen if you could still afford monthly payments at 4.79%, or $2,278.83.

Cut to today at 5.25%, and you’ll need to be able to afford $2,383.67 per month.

This isn’t a huge amount of difference per month, but for someone that qualified for a $400k loan before, they would now qualify for about $380k. And that would mean potentially coming up with another $20k downpayment! Bear in mind that this is quite a small mortgage, and the difference for bigger loans will be much bigger!

So you’ll see, that’s a significant change in affordability for some buyers, and it’s important to be aware of this if you’ve been looking over the past few months and were searching in a certain price range! If you were looking at properties that maxed out what you’d qualified for, you may have to lower your max price slightly.

Who does this new stress test apply to?

Originally this would only apply to people getting high ratio mortgages (under 20% downpayment), but it now applies to anyone applying for a mortgage.

Are there any exceptions?

Yes, if you were already prequalified prior to June 1, then you may be ‘grandfathered in’ with some banks, however some banks are requiring an accepted offer to be included in the previous rates. It’s important to speak with your bank or mortgage broker to find out exactly what your situation is.

What other options do I have?

Although all banks and financial institutions are required to follow the rules of the stress test, some provincial lending institutions and credit unions are able to look at the bigger picture and not only use this metric as their qualifying criteria. Even if you don’t pass the stress test, some banks may not automatically disqualify you for the higher amount you’re looking for. This is why it’s important to use a mortgage broker if you think your situation might be a little more complicated or untraditional.

How to maximise your financing amount after the new stress test rules?

If the stress test is here to stay, then the best way to increase your qualification amount is to reduce your monthly payments. Your total debt is an important number, but when qualifying for a mortgage it’s often your monthly payments and debt service that’s compared against your mortgage payment affordability. If you can lower any of your monthly payments, it will have a much larger effect on what you can qualify for, compared with reducing your total debt.

Example

Say you had two cars – car 1 costs $300 per month in payments ($5k remaining balance), and car 2 costs $600 per month ($20k remaining). And let’s say you had $5k available to pay down the debts.

Spending the $5k on car 1, and entirely removing the $300 monthly payment will have a far, far bigger effect on your monthly debt service amount, vs splitting it between the two or putting it all on car 2.

Strategically reducing your monthly payments (assuming you have some) can really help boost your mortgage qualification amount, and might help you make up what you just lost in the stress test!

Final thoughts

The stress test doesn’t have to be stressful, but it’s important to understand what it means for your own personal financial situation. It’s also important that your realtor is aware of the latest updates from the government and can adjust their search for you accordingly.

At RE/MAX Cascade Realty, we stay on top of all the latest market news to help guide you competently through the home buying process. If you’d like to chat with me or a member of our team about a property. Please feel free to contact me through any of our contact forms, or on my cell (4034012066).

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