New stress test mortgage rules: how much home can you really afford?

by Emma Scott on 07 May 2021

If you are looking to invest in a new home in Canada but haven't heard about the new Stress Test Mortgage rules - or even heard of the test at all - there is a chance that your move may not go the way you wanted it to.

If you are entering the housing market or you are a new homeowner, there is a chance that you have heard about the Mortgage Stress Test. No, this is not a physical test to determine how well your heart works, but it could definitely put a strain on it. The Mortgage Stress Test is just how it sounds; it determines how your mortgage and finances might be affected by a sudden change in your financial situation, like unemployment.

Recently, Canada's banking regulators suggested new rules for the Mortgage Stress Test because of the COVID-19 pandemic putting people out of jobs, but at the same time, causing the housing market to soar to new heights. But even with an attempt to cool the booming housing market, these rules will make it more difficult for potential home buyers as their qualifying rates increase. More on that below.

The Canadian Mortgage Stress Test explained

The Office of the Superintendent of Financial Institutions (OSFI) created the Mortgage Stress Test to prepare buyers for the financial stress of being homeowners.

The test determines how you, as a homeowner, would be able to handle sudden and drastic changes in either your financial situation or mortgage payments in the event of rising interest rates and or unemployment. In short, it gives you a glimpse at the high expenses of being a homeowner and helps you determine if you would be able to afford your home if interest rates rose or your household income changed for the worse.

All buyers in Canada are required to complete the Mortgage Stress Test to determine whether their mortgage loan is viable for them based on their income, property tax, and other debt (e.g., student loans, credit card debt, car payments). Bank lenders can help complete evaluations of your finances to determine what mortgage payment would be right for you. 

Although all Canadian buyers need to take the Stress Test, the minimum qualifying rate for uninsured mortgages has changed. If you are getting an uninsured mortgage - meaning you are paying a 20% down payment on your home - you will face higher qualifying rates come June 2021.

A rising qualifying interest rate

In April 2021, the Office of the Superintendent of Financial Institutions revised the Mortgage Stress Test. Before, the qualifying rate rested at 4.79%. Now, to pass the test, mortgage owners need to prove that they can qualify at either their contracted mortgage rate plus 2% or at the Bank of Canada's five-year benchmark rate of 5.25%, whichever is higher. 

So, if you have an insurance rate of 2.25%, you need to prove that you can qualify at 4.25%. If your rate is currently 4.5%, you need to prove that you can qualify at the Bank of Canada's 5.25%.

The two percentage points increase has a startling effect on many looking to buy a home without mortgage insurance. For those who have opted for a variable rate mortgage, the Stress Test can provide a scary glimpse of what could be on the menu if their interest rate changes.

Homebuyers considering an uninsured mortgage may need to reduce their budget and pay off other debt to prove to their lender or the government that they can afford their mortgage.

New concerns for home buyers

To pass the Mortgage Stress Test, borrowers need to prove that they can qualify at either their contracted mortgage rate plus 2% or  5.25%, whichever is higher.

A borrower's largest cause for concern is having to adjust - and most likely reduce - their budget.

For example, if you buy a house at the purchase price of $500,000, make a 20% down payment ($60,000), and receive a rate of 3.8%, you are required to pay a monthly interest rate of $1,401.63. To complete the Stress Test, you need to prove you can pay 5.2.5% or $2,492.15 a month in mortgage rates! A  loan payment like this could easily cause homebuyers to default if they are not prepared.

This move to change the B-20 Mortgage Stress Test will undoubtedly cause more borrowers to reconsider what they can afford based on their income and other financial commitments. Canadian mortgage owners now need to consider how they could complete debt payments, pay off their credit cards, pay their property tax, and other financial commitments if their interest rate rose two percentage points.

Borrowers should take the time to evaluate their finances with the help of their bank before approaching a realtor with their budget. Receiving lender advice early on will set buyers up for success without getting their hopes up or worse - trying to make payments on a house they can't afford.

If they need to prove that they can pay at most 5.25% of their mortgage in interest, their budgets will reduce.

Homebuyers with large debt may have a more difficult time receiving a home loan from the bank of their choice.

Canada's housing market battleground

Canada's Booming real estate market has spurred the government regulator to up the Stress Test.

The Canadian housing market has boomed in 2020 and 2021. Interest rates have remained historically low, causing people to flood the market and purchase a new home. This overwhelming demand has been difficult to keep up with, causing housing costs to increase dramatically. Due to the low supply and increased demand for houses, the housing marketing has turned into a battleground where the one with the greater purchasing power wins.

In an attempt to cool the market, the government instituted the new benchmark qualifying rate for uninsured mortgages. In a letter to the banks, the OSFI said that the new qualifying rate for uninsured mortgages "ensures that the financial system is adequately prepared for the possibility of a return to pre-pandemic economic condition." In short, they want to make sure that borrowers can make their payments if the market returns to normal.

Bank and mortgage industry professionals' insights

OSFI is not the only one concerned about home buyers being able to pay their mortgage loans. Bank lenders are worried about borrowers overreaching in the highly competitive real estate market.

Tiff Macklem, governor of the Bank of Canada is quoted in a Financial Post article saying, "Given elevated levels of household debt and the risks that households may overstretch in the face of rising housing prices, we welcome the recent proposal by the Superintendent of Financial Institutions to introduce a fixed floor to the minimum qualifying rate for uninsured mortgages."

The chief executive officer of the Royal Bank of Canada said that the change to the Test is likely to swiftly impact the housing market, noted a Financial Post article. However, he said he is unsure if it will affect market conditions the way the government wants it to.

Mortgage Stress Test, Canada

The new Mortgage Stress Test rules will help ensure that people buying homes at low-interest rates can handle a potential increase in their mortgage payments. OSFI's advice, hidden in the form of an increase to the qualifying rates, is for buyers to remember and prepare for increases to their mortgage interest rates.

The 5.25% or two percentage point Stress Test rate will come into effect in June 2021.

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