Just as you would wear a rain coat when the forecast calls for rain or pack a plethora of distractions for a long-car ride with your kids, we plan for worst case scenario when taking out a mortgage.
What is the Stress Test?
In financial terms, this planning is called a stress test and it involves looking at all the possibilities and modelling a worst-case scenario before making an investment. A mortgage stress test is a way to determine exactly how much you can afford before you make a purchase. If your income was reduced could you still make your portage payments? What if interest rates spike?
In Canada, doing a stress test is a legal requirement when you have a “high ratio” mortgage (a down payment less than 20%) so that you can rest assured that you will be able to afford your mortgage, no matter what life throws at you.
How do they do the Stress Test?
When you apply for a mortgage, the bank will check that you will be able to make your payments based on the Bank of Canada qualifying rate (mode average of the posted fixed rates over the past 5 years). So even if you can get a 5-year fixed rate today of 2.07%, you’ll still need to qualify for the Bank of Canada qualifying rate of 4.79%.
What does this mean?
In order to qualify for a high ratio mortgage, your existing debts need to be low enough that when combined with your income, you still have enough money should you need to pay down your mortgage at a higher rate.
Generally, this means that you will be able to borrow a smaller amount of money than someone in a comparable situation who did not have a high ratio mortgage.
Changes to the Stress Test
Since it was introduced, the mortgage stress test has changed a number of times. It has already been lowered 3 times since the beginning or March from 5.19% to 5.04%, and then again in May to 4.94%, and just recently to 4.79%.
How do you stress test yourself?
How do you figure out what minimum monthly payment you’re required to be able to afford? Use a mortgage calculator and run multiple scenarios to determine what your monthly payments would be if interest rates rose. Compare these results to your monthly budget before you buy a home that may be too expensive in the future. If you find that you can’t afford the payments at a higher rate, you may need to weigh your options. Do you save a larger down payment and defer the purchase of your home? Do you choose a more affordable home?
It’s important to keep up-to-date on changes to Canadian mortgage regulations as they can directly impact your mortgage. Contact me anytime and I will put you in touch with a trusted mortgage expert to help answer all your questions.