You have heard the term, maybe on the radio, in a newspaper or in the news.
Stress Test. But what is it exactly?
A mortgage stress test is a way of determining exactly how much you can afford (and under what circumstances). If your income was reduced or you lost your job, could you still afford to make mortgage payments? What if interest rates spike or you need to refinance your home? Could you still afford your payments?
This type of rainy-day planning is important for a few reasons. First, interest rates fluctuate. So do home prices. According to the Canadian Real Estate Association, Canada’s average home price was over $568,000 in January 2021, up 13.1% from a year before. Knowing you can still afford to pay your mortgage if interest rates increase is important, and could affect the kind of home you decide to buy. This is why the stress test has a role to play despite those that find their affordability reduced as a result.
Since 2018, all Canadian homebuyers getting a high-ratio mortgage (less than 20% down) have been subject to a mortgage stress test – the test now applies to all mortgages. The mortgage stress test requires banks to check that a borrower can still make their payment at a rate that’s higher than they actually pay.
How it Works
Here’s how it works. When you apply for a mortgage (including joint mortgages), you’ll be offered a contracted rate – hopefully, this will be as low as possible! However, your bank needs to check you’ll be able to pay back your mortgage, even if your mortgage rate rises during your mortgage term.
To do this, they check your ability to make your payments based on The Bank of Canada qualifying rate, which is based on the mode average of posted 5-year fixed rates from Canada’s big banks. Currently, the Bank of Canada qualifying rate is 4.79% (even though there is a current proposal to bump it back up to 5.25%)
This means that your income needs to be high enough, and your existing debt low enough, to be able to pay down your mortgage at that higher rate. Generally, this will result in you being able to borrow a smaller amount of money and purchase a lower priced property.