Mortgage Stress Test: What to Know

By Rachel Burke

Mortgage lenders aren't the only ones who want to know where you stand financially. The government may also call on you to provide information about your income, assets, debts, and expenses. These are the kinds of details that lenders use to determine how much you can afford to borrow and how long it will take you to pay off the mortgage on your home. Specifically, the Office of the Superintendent of Financial Institutions (OSFI) is responsible for verifying that borrowers will be able to continue repaying their mortgage. Sounds good? Let's get started!

What is the Mortgage Stress Test?

To ensure that Canadians can continue to afford their homes in a rising interest rate environment, the OSFI has mandated that all borrowers undergo a stress test. Since June 1st, 2021, OSFI has also made the rules to the mortgage stress test applicable to borrowers who make a 20% down payment or more.

Why is the Mortgage Stress Test Required for Borrowers?

The Mortgage Stress Test is meant to protect the banks from liability if interest rates rise and cause borrowers to fall behind on their mortgage payments. Since many Canadians have a variable rate mortgage, they are exposed to fluctuating interest rates. A change in interest rates could create an income shock that may be difficult for them to handle, leading to a default. 

What Are the New Mortgage Rules?

Borrowers will have to qualify for their mortgage at OSFI’s benchmark rate of 5.25% or the rate offered by the lender plus 2% (whichever is higher). That means that borrowers will now have to qualify for their mortgages at that rate. If they would be unable to pay their payments at today's super-low rates, chances are they could get into financial trouble further down the road.

The qualifying mortgage rate is designed to protect the Canadian housing industry. These changes might impact the kind of mortgage you are eligible for, and you may have to decrease your budget or put more money down on the mortgage. The qualifying rate is revised every year by the Department of Finance or OSFI to adjust according to the state of the real estate market and economy.

As an example, let’s say a household has an income of $100,000 and a down payment of $100,000. Based on a mortgage rate of 2.24% and a previous qualifying rate of 4.79%, you may have been able to afford a home at around $463,000. However, with the new qualifying rate of 5.25% and the same mortgage rate, that household can now only afford $447,000 (4% lower). By increasing the down payment by $16,000, the household will be able to afford the same home with the new stress test rules. 

How to Stress Test Your Mortgage

How do you find out what minimum monthly payment you need to be able to afford?

When applying for a mortgage, you can compare the current bank mortgage rates and how they will impact your monthly payment. However, it’s possible that interest rates can increase in the future. For borrowers with variable interest rate mortgages, changes in interest rates immediately affect one’s mortgage payments. Borrowers with fixed interest rates will keep the same rate for the duration of their term; however, they might also have to face a rate increase at the time of their renewal. 

It’s not possible to predict exactly how mortgage rates will fluctuate, but testing with a range of 2-3% is a safe bet. For example, if someone purchases a home at $500,000 with a 20% down payment at an interest rate of 2.89%, their monthly payments will be $1,753.57. When the time of renewal comes at the end of the term, let’s say the mortgage rates increase to 5.34%. The monthly payment then becomes $2,254.16. Will that person be able to afford that payment increase?

If not, then the borrower needs to consider their options. Can they save a larger amount of money to put towards a down payment and put a hold on making a home purchase? Or do they choose a more affordable home? That’s something they will have to decide themselves, or they can consult a financial advisor. 

Deciding on the Right Mortgage For You

If you're considering buying a house, chances are you're shopping for a mortgage. It’s important to do your research on the current Canadian mortgage regulations as they change frequently. Understanding what factors, such as the stress test, go into a mortgage is key to finding the right lender for you since it's not just about how much you can afford. It's also about what kind of mortgage is best for your unique situation. A mortgage broker can help you shop for the best deal and explain your options.