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January 1, 2020 marked the two year anniversary since the mortgage stress test came into effect. If you’re planning to get a mortgage or renew or refinance your mortgage in 2020, you’ll want at least a basic understanding of the stress test and how it impacts you.
The stress test has certainly had an impact on the real estate market.The B.C. Real Estate Association released a report last year suggesting that home sales in the province would have been 10 percent higher without the stress test.
In this article we’ll look at what is the mortgage stress test (the mortgage stress test explained), what are the new mortgage stress test rules, how to prepare for the mortgage stress test, how to avoid the mortgage stress test and what to expect from the mortgage stress test in 2020 and going forward.
If you’re buying a home and getting a mortgage, you’ll have to pass the mortgage stress test in order for your mortgage application to be approved. Likewise, if you’re already a homeowner and you’re looking to switch lenders and renew your mortgage at the new lender or refinancing your mortgage with your current lender or a new lender, you’ll be required to pass the stress test as well.
The Office of the Superintendent of Financial Institutions (OSFI) brought in the Canada mortgage stress test in January 2018 because it was overly concerned with the level of household debt Canadians are carrying. To avoid payment shock upon the renewal of your mortgage, OFSI wanted you to be able to prove you could handle higher mortgage rates if and when they arrive; hence, the new mortgage stress test was introduced.
The mortgage stress test rules are federal guidelines. As such, all federally regulated mortgage lenders are required to abide by them. All six of Canada’s big banks are required to follow the new Canadian mortgage rules. Similarly, some provincially regulated financial institutions, such as credit unions, are choosing to voluntarily comply with the new Canada mortgage rules.
As mentioned, if you’re getting a mortgage, renewing or refinancing your mortgage, you’ll need to pass the new mortgage rules in Canada.
Let’s say you’re buying a condo for $500,000 in the Greater Toronto Area. You’re putting $100,000 down (20 percent), leaving you with a mortgage of $400,000. When qualifying you for a mortgage, lenders look at several factors, including your:
The new mortgage rules for a down payment come into play here.
Lenders want to make sure you afford to carry the home on a monthly basis. That’s why you’re required to pass two debt servicing ratios.
The first debt servicing ratio is the Gross Debt Servicing (GDS) Ratio.
The second is the Total Debt Servicing (TDS) Ratio.
The GDS Ratio looks at the percentage of your gross monthly income needed to cover your mortgage payments, property taxes, an amount for heat and 50 percent of the property’s maintenance fees (if applicable).
Similarly, the TDS Ratios looks at the same things, except it also includes any other debt you might have outside of the mortgage.
Most mortgage lenders are looking for a GDS Ratio below 39 percent and a TDS Ratio below 44 percent. This sounds simple enough. However, the mortgage stress test has changed the game. Instead of using your actual mortgage payments for debt servicing purposes, the inflated stress test mortgage payments are used. What do I mean by this? Let’s go back to our example from early.
Let’s say your annual salary is $100,000. You decide to buy a condo. The annual property taxes of the condo are $2,000, the monthly maintenance fees are $500 and the lender estimates $100 per month for heat. Let’s say you’re qualifying for a 2.99 percent five year fixed rate mortgage with a 25 year amortization. At a mortgage rate of 2.99 percent, your monthly mortgage payments would be $1,891.
Prior to the introduction of the mortgage stress test, your GDS and TDS Ratios would be 32 percent respectively. That’s because you could qualify based on your actual mortgage rate rather than the inflated stress test rate. As you can see, you’re well below the 39 percent GDS Ratio and 44 TDS Ratio required by lenders. As long as everything else checks out on your mortgage application, you shouldn’t have any problem getting approved.
However, that was then and this is now. Under the mortgage stress test in affect today, you’re required to qualify for a mortgage at the greater of your mortgage rate plus two percentage points and the Bank of Canada’s five-year benchmark rate (currently at 5.19 percent). Since 5.19 percent is higher than 4.99 percent (two percent plus your mortgage rate of 2.99 percent), you’d have to qualify at 5.19 percent.
In this example here, your GDS and TDS Radios are suddenly a lot higher. Instead of only being 32 percent, they’re suddenly close to 38 percent. You should still qualify to buy the property you want to buy, but as you can see from this example, the stress test added an extra seven points on your GDS and TDS Ratios. You were fine this time, but if you wanted to spend more on a property, unless you could put more money down, you’d no longer qualify for the mortgage.
This was just one example. Everyone’s financial situation is different. I’d encourage you to use a stress test calculator if you want to run the numbers for yourself.
As mentioned in the last section, in order to pass the mortgage stress test, your GDS and TDS Ratios will need to be below those required by the lender of your choosing.
The best thing to do is identify why you’re running into difficulty. Is it because you want to buy a home outside your purchase price or is it because you have too much debt? Once you identify the problem, you can work towards rectifying it and passing the stress test.
Let’s say it’s because you simply don’t have enough income to buy the property. There are several ways around this.
The simplest way is to buy a less expensive property.
However, if you’re buying in a big city like Toronto or Vancouver where home prices are higher than the rest in the country, you may not be able to find any property in a lower price range.
If spending less on a property isn’t an option, you might consider buying a property with a co-applicant or co-signor.
With a co-applicant or co-signor, you can include the co-applicant or co-signor’s income for mortgage qualification purposes. If the co-applicant or co-signor earns a decent amount and has little to no debt, it can really help boost your purchasing power and pass the stress test.
Other ways to pass the stress test include:
If you still can’t pass the stress test, you might consider applying at a provincially regulated credit union. Some provincially regulated credit unions have chosen to abide by the mortgage stress, but not all lenders have. Although you may have to pay a higher mortgage rate, it may be worthwhile if it can help you pass the stress test and purchase the property that you want.
Lastly, another option to look into is taking out a mortgage with an alternative lender. Although alternative lenders may apply the stress test, an alternative lender’s GDS and TDS Ratios tend to be more lenient, making it easier to pass the stress test.
If I look into my mortgage market crystal ball, there are some interesting mortgage changes we could see in Canada in 2020.
Last year we saw the first drop in the mortgage stress test rate in three years. In 2019 the Bank of Canada’s five-year benchmark rate dropped from 5.34 percent to 5.19 percent where it currently sits. This happened because the big banks lowered their posted mortgage rates.
Could we see the 5.19 percent stress test rate come down further in 2020? Only time will tell. With the coronavirus leading causing the government of Canada bond yields to fall, it’s a distinct possibility.
It’s also possible that the mortgage stress test rules could be loosened. Again, I wouldn’t hold my breath,although OFSI has said that it’s currently reviewing the stress test to see if changes are needed.
