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What home buyers should know about the Canadian mortgage stress test

March 9, 2020 Tamar Satov
What home buyers should know about the Canadian mortgage stress test

When you apply for a mortgage, the bank will offer you an interest rate based on credit score. Under the stress test, however, that is not the rate the lender will use to determine your mortgage eligibility. Rather, it will make those calculations at a considerably higher interest rate, to ensure you’ll be able to make your payments if/when rates go up, as explained above. 

So, what interest rate will your lender use? Until April 6, the minimum qualifying rate for both uninsured (with at least 20% down payment) and insured (less than a 20% down payment) mortgages will be the higher of the following: 

To put this into real terms, if you wanted to borrow $400,000 and your lender is offering you a rate of 2.5%, you would have to prove you can afford a mortgage payment of about $2,370 per month (at 5.19%), even though your actual monthly mortgage payment (at 2.5%) would be about $1,790.

After April 6, the minimum qualifying rate for insured mortgages only will change to be the higher of:

  • The weekly average five-year rate on all insured mortgages, plus 2% 
  • The rate offered by your lender, plus 2%

At the time of writing, that first rate stood at about 4.89%. So, using our example above, you would have to show you could afford a monthly payment of approximately $2,300—or about $70 less than under the pre-April 6 benchmark. Obviously, the more that you are borrowing, the greater that difference will be.

How does the bank determine what I can afford?

There are two main figures banks use in this calculation, Rasiawan says. “First is GDS [gross debt service ratio], which is the percentage of the borrower’s pre-tax income that will cover housing costs [including mortgage, heat and property taxes] and it should be no more that 32%,” she says. “Then there’s TDS [total debt service ratio], which is any outstanding personal debt [including mortgage, car loans, credit card debt, lines of credit, etc.] and should be no more than 40% of pre-tax income.”

Going back to our $400,000 mortgage example above, if we assume heating and property taxes brought your total monthly housing costs to $3,000, you’d need a pre-tax monthly income of at least $9,375 (or $112,500 annually) to have a GDS of 32% or less. Similarly, based on that income, your total debt load could not exceed $3,750 per month (including your mortgage payment) to have a TDS of 40% or less in this scenario.

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What does the stress test mean for borrowers?

If you are a first-time potential homeowner trying to get a foot into the market, the stress test makes it a lot harder for you, Rasiawan says. “My brother, for example, was applying for an uninsured mortgage and under the old (pre-2017) rules would have been able to qualify for $450,000 but can now only get $380,000,” she says. “That’s a huge difference when you’re a first-time home buyer.”

As for the upcoming change for insured mortgages, Rasiawan thinks it may help some buyers who are on the edge of passing the stress test, but cautions that it isn’t a magic bullet for first-time home buyers. “With the hot real estate market, limited supply, and increases in prices, it’s still hard for first time buyers to break into the market,” she says.

Renewing mortgage holders only need to “pass” the stress test if they switch lenders. “But they can’t really shop around for a better rate or negotiate with their existing lender when they renew, so it affects them as well,” she says.

Is there any way to side-step the stress test?

Not really. Canada’s big banks are mandated to enforce these rules while other lenders, such as credit unions, use them voluntarily to reduce their risk exposure. Still, there are steps borrowers can take increase home affordability, according to Rasiawan. “Save up more, pay down other debt or get a co-signer,” she says. “That will qualify you for a larger mortgage.”

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