The “stress test” rule can be a little complicated to understand. Here’s a break down of why the rule exists and how it will apply to your mortgage.
What does the mortgage “stress test” really mean when applying for a mortgage?
When you buy a home in Canada your mortgage is “stress tested” to ensure that you can comfortably afford the mortgage payment in a rising rate environment. The “stress test” rule is aimed at addressing concerns that extremely low-interest rates have encouraged Canadians to overextend themselves financially, posing a risk to the housing market. The government wants to ensure when interest rates rise, Canadian homeowners can afford a higher mortgage payment on their mortgage maturity date.
When your current mortgage term reaches its maturity date, you’ll need to renew the outstanding balance for another term. If rates increased, the new mortgage payment would increase. To ensure that Canadians can afford a payment increase the “stress test” rule is applied.
Insured mortgages are required to use the Bank of Canada’s Conventional mortgage – 5-year rate for qualifying purposes. Uninsured mortgages are required to qualify at the greater of the Conventional mortgage – 5-year rate or the contractual mortgage rate plus 2 percent. Even though you are being offered a lower rate by your lender, you have to follow the government of Canada’s qualifying guidelines.
For example, you want to buy a home for $375,000 and saved up a 20 percent ($75,000) down payment. You’ll require a mortgage of $300,000. If a lender is offering a five-year, fixed-rate mortgage at 3.99 percent, with a 25-year amortization, the payment would be $1,576.45. With the stress test, you’ll have to qualify 2 percent higher, at 5.99 percent. The monthly qualifying payment is increased to $1,917.64. The higher payment is used for qualification purposes only and tests a borrowers ability to pay their mortgage if actual rates were to rise. The stress-tested payment is what lenders use in their debt servicing calculations.
The stress test is meant to ensure Canadians are not buying homes they can not afford in the future. This will help ensure the Canadian housing market stays strong. See what mortgage amount you can qualify for by downloading our free mortgage app today.