In 2017, a new Canadian mortgage law specified that every Canadian who was applying for an unsecured mortgage at a federally regulated financial institution had to pass a mortgage stress test. Even a hefty down payment was not a sufficient reason for waiving the test. The new rules came into effect on January 1, 2018.
Why was the Mortgage Stress Test implemented?
Some of those seeking mortgages insisted it was to make it more difficult for them to secure a mortgage. That wasn’t the reason although these new rules regarding Canadian mortgages could, however, make it tougher to qualify.
Rather, the stress test is intended to be used as an instrument to discern whether those seeking an unsecured mortgage could deal successfully with rising mortgage rates. This test is supposed to answer the question: Will this borrower be able to repay this loan if interest rates climb?
There’s another reason: These changes in mortgage rules aim to act as a safety net for the Canadian housing industry. They are also to ensure Canadian consumers aren’t spending beyond their ability to pay.
Here is a scenario: Let’s say a household’s combined income is just under $90,000 and they could afford a twenty percent down payment. Before the new mortgage stress test, their house affordability might have been greater than $500,000. With the new mortgage rules in place, they would be able to afford a home just under $400,000.
What’s is the purpose of the Test?
This is not a traditional paper-and-pencil test. There’s nothing you have to study for. The test simply means that your status will be examined to see if you meet a minimum qualifying rate.
Stipulations for the New Canadian Stress Test Rate
According to the new rules, the minimum qualifying rate has to be the Bank of Canada five-year benchmark rate OR a mortgage rate over two percent—whichever is higher.
Lenders’ loan-to-value must be responsive to current lending risks. New restrictions seem aimed at circumventing loan-to-value limits.
Does this sound complicated? Here is an example: Let’s say the lending institution offers you a rate just a touch under three percent. The benchmark on your stress test would then be just over five percent. Assuming you can make the suggested twenty-percent down payment and are offered a rate of just under three and a half percent, your stress test rate would be approximately five and a half percent.
Why be Concerned?
Anyone who is applying for an unsecured mortgage to buy a house will be affected by the new rules. Basically, as a borrower, the onus will be on you to show proof of your ability to honor your mortgage payment each month even if the interest rates increase.
If you’re feeling relieved that you got your mortgage before January 1, 2018, don’t get too comfortable. If the time comes when you need to refinance, or you are forced to take out a home line of credit, then you will have to take the stress test. If you switch mortgage lenders to one under federal regulations, you must take the test. If you renew your mortgage with the present lender, you won’t have to take this test.
A Toronto Dominion Trust economist has estimated that the new stress test will lower housing demands by up to ten percent. It will also reduce house price growth by up to four percent. This also means home sales could shrink by up to fifteen percent.
What Do Canadians Feel about the Test?
According to a 2018 homebuyers’ survey, over twenty percent of Canadians don’t know about or understand the new rules. Thirteen percent aren’t concerned because they are not seeking a loan from a bank. Lending institutions like credit unions and other individual lenders not federally regulated are not under the rules of the mortgage stress test.
However, when the situation about rising mortgage rates is raised, three in four Canadians believe interest rates on home loans are going up. Nearly four in every ten are convinced mortgage rate increases will occur soon. One in four believes home loan rates will continue to increase.
Whether they are potentially new home buyers or people who already hold a mortgage, just under half of those surveyed stated that they had no plans to take the stress test regarding their mortgage. Should the increase many of them expect occur, they noted that they are prepared.
Are the New Rules Helpful?
Many who are applying for an unsecured mortgage at a federally regulated institution may see the new rules as the cause of a rise in mortgage rates. Some see it as another hoop they have to jump through to get a mortgage. Some are angry. Others are frustrated.
However, the reality is that mortgage rates will most likely rise. The mortgage stress test actually ensures that optimistic Canadians don’t over-extend themselves when it comes to purchasing a home.
What are New Homebuyers Seeking
When they consider fixed versus variable mortgage rates, new home buyers are very much affected by what they perceive as escalating mortgage rates.
Only thirteen in every hundred surveyed said fluctuating rates would not affect the type of mortgage they chose. Almost a third stated that they would choose a fixed-rate mortgage and five in a hundred were certain their choice would be a variable rate mortgage.
What about Mortgage Holders?
Those who already have mortgages may also be affected by rising rates. The one in four who opted for a variable rate mortgage will be immediately impacted. If they are part of the nearly seventy percent who chose a fixed-rate mortgage, they won’t be affected immediately. However, when their present term ends, they can expect a new rate that is at least five percent higher.
Are Home Owners Happy with their Present Mortgage?
Over three in every for surveyed have no desire to change the mortgage they presently hold. For many of them, it was a case of don’t rock the boat. Better to stay with a known entity than to risk something new. Regardless, as of January 2018, all new homebuyers are required to stress their mortgage.
How to Stress Test Your Mortgage
If you are a new homebuyer seeking an unsecured loan from a government-regulated lender, it’s logical that you would want to see how you will fare on this test before you are asked to take it. Those who are concerned that their present mortgage might be affected might also want to take this test to see how much their monthly mortgage payments might raise.
It’s easy to take the test. Take the current Bank of Canada five-year benchmark rate which is just over five percent and apply it to the mortgage rate you are being offered. Every Canadian bank has a mortgage calculator which you can use for this purpose.
Here is a scenario from one mortgage holder who recently bought a new home. He paid just over $725,000. He paid $50,000 down. The rate offered by his lender is just under three percent. Currently, his monthly payment is just over $3,300.
If he “stress-tests” his mortgage, the rate is just over five percent. To pay off the principal amount described in the scenario above, his monthly mortgage payment would increase to almost $4300 a month. That is a nearly thirty percent increase! According to the mortgage stress test, you need to ask yourself if you could still be able to pay the increase.
I know what you are thinking: Rates might not ever—or at least not soon—go that high. But, think about this: even a percentage or two calculated over a long time can really add up.
Many mortgage companies with variable-rate mortgages might not increase rates immediately. However, you are not paying off as much of the principle with every interest rate increase. Do the math. If you expect to pay off the mortgage at the same time you expected to do so before rate increases, then of course mortgage payments will have to balloon. You have three options.
- As I suggested, your mortgage payment will have to increase. If you can swing it, this is probably the best choice.
- To offset the interest hike you could make one large payment or several smaller payments. If you opt for this choice, then time is not on your side. Do it as quickly as you can.
- Because you can’t sustain a higher monthly mortgage payment or you don’t have the cash for a lump sum payment, you could do nothing. Maybe your present mortgage payment is all you can afford. You could continue to make these payments. However, when rates increase you know that each month, you will be paying more interest and less principal. You will then not be paying off your mortgage when you hoped you would.
It’s a big decision. You may have to choose option #3 because the other two are just not feasible at this point in your life. It may be a question of budgeting. If thirty percent of your income already goes to your mortgage and option #1 means this increases to seventy percent, then this is highly unlikely for most people to handle.
Debt Stress Test
According to a homeowners’ poll, over eighty percent of homeowners owe money. Over ten percent have what they see as “massive debt”. Over forty percent have “major debt” while nearly thirty percent describe their situation as having “a little debt”.
Over seventy percent of those with debt cite mortgage payments as the number one debt source. Generation X people have what they see as “great debt”.
Dealing with Debt
Increases in mortgage rates could well put a serious strain on Canadian households. Economists suggest preparing for higher mortgages by creating or revising the family’s budget. Start by using your financial institution’s mortgage calculator to discover how much the increase in your mortgage could logically be.
Next, list your other debts and payments like student loans, car payment, utilities, property taxes, home maintenance costs, entertainment, foods, clothing, and gas.
The Bottom Line?
Ask yourself: Can I meet all these payments? That’s what the new mortgage stress test is all about. If you cannot meet all these payments, you may have to opt for a smaller home or you may be forced to delay purchasing a house. You may have to think about buying in a less expensive area.
If you already own a home but were considering a move to a different lender, this might not be the best time to change lenders.
Let Lenders Help
There is no doubt about it. Those who are hoping to buy a home will have their financial situation more carefully scrutinized than before the new rules came into play. New home buyers will be forced to prove that they will still be able to make mortgage payments even when interest rates go up.
We’re at a time when negotiating a mortgage for a new home is very complicated. Don’t try to do this all by yourself. Lending institutions have competent people who will help you. Talk to loans officers where you bank. Discuss mortgage options with people where you hope to negotiate a mortgage for your new home. Not all mortgages are equal. Be ready to negotiate the best mortgage deal for your family. Look at both fixed and variable rates. Do your homework before you start negotiations. Know your mortgage stress test, your debt load, and your assets. Be prepared to show you can still make monthly mortgage payments if interest rates increase. Make good use of lender resource people. Remember: Luck favors the prepared mind.