If you are planning to buy a home in Canada, you are probably taking a mortgage. Before you take the plunge, it is important to be aware of the Mortgage Stress Test, a legal requirement in Canada.
What is a mortgage stress test?
Most often, a stress test involves modeling a worst-case scenario before an investment is made. It tests your ability to withstand interest hike rates with a proper financial bandwidth. Implemented by the Canada Mortgage and Housing Corporation (CMHC), the stress test requires you to qualify for a mortgage at a higher interest rate than what you actually pay. Nowadays, the rules for stress tests are stricter than before. Previously, the qualifying interest rate was 4.79%. But as of June 2021, the rate has gone up to 5.25%.
How does a stress test work?
When you apply for a mortgage, your bank will check if you have the financial ability to repay it even if your mortgage rate rises during the mortgage term. During this process, they look at your ability to make payments based on The Bank of Canada qualifying rate. This rate is based on the average of posted five-year fixed rates from Canada’s biggest banks.
What this essentially means is this: You need a high income and an existing low debt to be able to pay your mortgage at a higher rate. To help you understand the stress test, we’ve created an example with hypothetical numbers.
Let’s say you are planning to buy a house that costs $500,000. You can afford a 5% ($25,000) down payment, and you are getting an additional 15% ($75,000) down payment support. This leaves you with a mortgage requirement of $400,000.
As per the current stress test rate, to qualify for a mortgage of this amount, you need to earn an income of roughly $107,000. It is the Canadian government’s way of ensuring you can afford to pay your mortgage even if the rate fluctuates.
Mortgage Stress Test: Important Points To Note
- The stress test applies to uninsured mortgages where you make a down payment of 20% to avoid CMHC insurance.
- Insured mortgages with less than 20% down payment are not subjected to stress tests.
- Credit unions are not required to use the stress test when qualifying loans.
- The stress test is not applicable for mortgages that are renewed with your existing lender.
- If you’ve already received approval, the new stress test rules will not affect your mortgage.
The Bottom Line
It is safer to assume that your mortgage rates will increase in the future. Especially if you’ve opted for a Variable Rate Mortgage which is attached to your prime rate. In such cases, even the slightest increase in rate will affect your mortgage payment. You may be safer with a fixed-rate mortgage, but you could face a rate increase when your mortgage comes up for renewal.