Getting a mortgage to buy a home will likely be the biggest financial transaction of your life, so it’s important to understand what you can afford.
It’s also important for lenders to understand your ability to make regular mortgage payments. One way lenders assess how much mortgage you can safely manage – as well as their risk in lending to you – is a mortgage stress test. This test evaluates your current financial standing and is a requirement for the majority of Canadian mortgages.
Let’s take a deeper look at what the mortgage stress test is, how it works and why it’s an important measurement for Canadians seeking homeownership.
What Is The Mortgage Stress Test In Canada?
The mortgage stress test is a calculation lenders use to determine whether a borrower will be able to afford their mortgage payments if additional strain (or “stress”) is placed on their finances due to rising interest rates.
For most Canadians, the mortgage rates they get will have the biggest impact on their monthly payments. This is especially true for homeowners who take out an adjustable-rate mortgage with rates that can increase or decrease depending on market changes. Regardless of loan type, higher rates typically mean larger monthly payments, which can lead to default if borrowers aren’t prepared for potential increases. The mortgage stress test helps borrowers and lenders minimize the risk of default by anticipating and avoiding unsustainable borrowing situations.
The Canadian government, through the Minister of Finance and the Office of the Superintendent of Financial Institutions (OSFI), uses the mortgage stress test to assess and mitigate mortgage default risk by setting up a minimum qualifying benchmark, currently 5.25%. We’ll get into more detail on how this benchmark works below.
While this system was designed to protect the Canadian housing industry, it can sometimes be a roadblock that forces borrowers to settle for a lower budget or come up with a higher down payment for a lower interest rate.
Is The Mortgage Stress Test Required?
The mortgage stress test is something that all borrowers in Canada are subjected to when applying for mortgages through federally regulated lenders.
A stress test is required regardless of whether you opt for a fixed-, variable- or adjustable-rate mortgage. It’s likewise required of borrowers applying for an insured or uninsured mortgage through a regulated financial institution.
If you already have a mortgage and choose to refinance, change lenders, or apply for a home equity line of credit (HELOC), you’ll also need to take a mortgage stress test.
How The Mortgage Stress Test Works
The OSFI sets qualifying stress test rates for uninsured mortgages while the Minister of Finance oversees insured mortgages. It’s important to note that any financial institutions that are not regulated by the federal government, such as credit unions or private mortgage lenders, don’t have to use the qualifying mortgage stress test, but can still apply it voluntarily any time they see fit.
The premise of the mortgage stress test is that you’ll need to qualify for a mortgage using the “minimum qualifying rate.” This rate acts as a benchmark to determine if you can continue to make your monthly mortgage payments when interest rates rise.
Currently, the minimum qualifying rate is set at either the lender’s rate plus 2% or the given benchmark rate (which the OSFI currently has set at 5.25%). Your stress test will use whichever figure is higher. In simpler terms, if your lender offers an interest rate below 3.25%, your qualifying rate will be 5.25%. Anything higher than 3.25% will use the contract rate plus 2%, since it exceeds 5.25%.
Let’s walk through an example. If your lender is offering you an interest rate of 3%, you’ll qualify at the benchmark rate – since 3% plus 2% is 5%, and 5% is lower than 5.25%. If instead your lender offers an interest rate of 4%, you will have to qualify at a 6% rate because it’s higher than the benchmark.
Mortgage Stress Test Rules
In order to pass the test, borrowers will need to prove that their income is high enough to support the minimum qualification rate as set out by the government.
New rules were put into effect with the mortgage stress test starting June 1, 2021. Originally the mortgage stress test rate was set at the mortgage rate plus 200 basis points (2%) or the Bank of Canada’s 5-year rate of 4.79%, whichever was higher. As of June 2021, the new rules apply to both insured and uninsured mortgages (where borrowers have at least 20% equity in their home), with the rate having risen to 5.25%, or the mortgage contract rate plus 2% if the latter is higher.
In response, OSFI Finance Minister Chrystia Freeland has said that “Maintaining the health and stability of Canada’s housing market is essential to protecting middle-class families and to Canada’s broader economic recovery.”
How Mortgage Stress Test Results Are Calculated
Mortgage brokers or banks will look at two main criteria when calculating how much house you can afford. The first is the gross debt service ratio (GDS) which is the percentage of the borrower’s pre-tax income that will cover housing costs like your mortgage, heating/cooling and property taxes. According to the Financial Consumer Agency of Canada (FCAC), your GDS should be no more than 32%, while the Canada Mortgage and Housing Corporation (CMHC) uses the limit of 39%.
The second is the total debt service ratio (TDS) which includes any outstanding personal debt like car loans, credit card debt, lines of credit and mortgages. According to FCAC, this should be no more than 40% of your pre-tax income, while CMHC uses the limit of 44%.
| Agency | GDS Limit | TDS Limit |
|---|---|---|
| FCAC | 32% | 40% |
| CMHC | 39% | 44% |
Do keep in mind that the amount of your down payment is still a big factor when it comes to buying a home and determining how much house you can afford. Remember that if you’re looking to purchase a home priced at $500,000+, you’ll be required to make at least a 20% down payment to qualify for a mortgage.
Can You Avoid The Mortgage Stress Test?
Unfortunately, there’s really no way to avoid the mortgage stress test if you’re applying for an insured mortgage since all of Canada’s big banks are regulated by the federal government.
If you’re opting for an uninsured mortgage through a provincially regulated lender, like a credit union or monoline lender, they may use a lower qualification rate than what’s mandated by the test on some of their offerings. For prospective buyers who may struggle to pass a mortgage stress test, an alternative mortgage product may be a way to make their dream of homeownership a reality.
The Bottom Line
The mortgage stress test, as its name suggests, ensures that a homeowner can manage their mortgage payments even if their interest rates go up by a certain amount. Provincially regulated lenders like credit unions and private lenders don’t often require a stress test for a mortgage, but you could face higher mortgage rates for it. If your finances and credit are in good standing, though, you may not need to stress about the mortgage stress test.
Looking to finance a home? Start the process today with Rocket Mortgage Canada, UL (Rocket Mortgage™).