The Mortgage Stress test has gone up. What's that mean?

That’s right folks, as of June 1st 2021 the Canadian Mortgage stress test has gone up from 4.79% to 5.25%.  To understand this and its consequences we first must make sure we know what the ‘stress test’ is.

The ‘stress test’ is a measure put in place by the OSFI (Office of the Superintendent of Financial Institutions), also known as…. the Federal Government.  The purpose of the ‘stress test’ is to ensure that people can afford to pay their mortgage if mortgage rates go up and they are forced to renew their mortgage at a higher rate.

So just to refresh you, or to let you know if you don’t already know….

In most cases mortgage terms are 5 years.  Let’s say you lock yourself into a mortgage for 1.99% amortized over 25 years with a 5 year term.  You will be forced to renew your mortgage for whatever the remaining principle is after the first 5 year term.  You may have got a 1.99% mortgage, but if the going rate five years later is 3.99% you’re about to take a huge hit on your monthly payments, the interest portion of your payments will double.  The 25 year amortization is just the number of years it would take to pay off your mortgage IF the term were to last till everything was paid off.  The term is the actual length of the contract.  Amortizations are most commonly 25 years and terms are most commonly 5 years, although they come in all different lengths, 1,2,3,4,5,7, and 10 year terms, the shorter the term length the lower the interest rate generally.  Either way, at the end of that term you would be susceptible to what we call interest rate risk.  Interest rate risk is what the ‘stress test’ aims to mitigate.

Up until June 1st of 2021 the ‘stress test’ was the greater of 4.79% or your rate plus 2%.  You had to prove you could pay your mortgage if the rate was 4.79% or 2% higher then your contracted rate.  So if your rate was 3.49% you would have to prove you could pay at 5.49%.

Now the rules are the same, except the qualifying rate is now 5.25% or 2% above your contract rate, whichever is higher.  Same rule bumped up higher, simple as that.

What do I mean when I say “prove you can pay your mortgage”? Well that’s a whole other blog about GDS (Gross Debt Service) and TDS (Total Debt Service).  The meat and potatoes of it is that those are mathematical ratios, they take your income compared to your debt and determine if you can afford your payments.

So how much does this change effect things?

Well let’s do an example shall we…

You borrow $300,000 amortized over 25 years at rate of 2.09% for 5 year term.  Your monthly payment would be $1283.42.  That’s a good example of today’s rates.

At the old qualifying rate of 4.79% you would need to prove that you could pay $1709.13 a month, because that’s what your payments would be if rates jumped to 4.79%.

At the new/current qualifying rate of 5.25% you now need to prove you could pay $1787.75 a month, even though your payments at 2.09% are only $1283.42.

The big thing you need to takeaway from all this is that the amount you are qualified to borrow is now lower.  How much lower?  Let’s do an example….

Let’s say you and your spouse make $100,000 combined, she makes 60k and you make 40K.  Between you both you have $1000.00/month in financial obligations. $600 for the vehicle, $200 on an old loan, and $200 for those nasty plastic cards.  Now those are monthly payment obligations, not balances.

So that’s 100k a year in income and $12000/year in debt obligations.  For this example we’ll also assume your property taxes are $3000/year and the heating bill is $1200/year (we have to factor in taxes and heat).

With the old qualifying rate 4.79% the people in this example would qualify to borrow $406,640.80

Under the new qualifying rate of 5.25% these people would qualify to borrow $388,755.94

Obviously as the numbers grow so does the difference, the easiest way to sum it up is that everyones borrowing power got knocked down by about 5%.

The idea here is that the Feds are trying to protect people from themselves by preventing them from overextending themselves financially.  That, and to try to cool the housing market to avoid any type of bubble from forming.

The best advice for people looking to qualify for a mortgage hasn’t changed.  You need to maximize the difference between your income and debt obligations.  It doesn’t matter if you make 200k if your credit cards are maxed and you have $2000 in car payments.  Likewise, although keeping your debt low is great, you still can’t qualify to borrow a lot of money without income to prove you can afford the payments. 

There are no laws against using the rules to your advantage.  If you are looking at buying a home in the future get your finances in order for the point in time you plan on purchasing your home.  What I mean by that is to put the vehicle purchase off till after you buy your home.  The rules are that you have to qualify to buy a home, not to hold a home.  The $5000 holiday that you were going put on the card needs to wait, that payment is crushing your buying power.

Now I’m not advocating for people to run up their cards and buy a car after you buy a house, what I’m saying is that if you do that nobody’s going to come and take the house away from you (unless you can’t actually make the payments of course). However, if you do that before you buy a house it could kill your chances of purchasing.  Get it? Good!

That about covers it!  Thanks for your time, I hope you enjoyed the read!

Dennis McNish

Centum Mortgage Professional

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