How The Mortgage Stress Test Works

If you're in the market for a home in Canada, you're going to be subject to what is called a stress test. If you're wondering what that is, look no further! This is how the mortgage stress test works. Simply put, the stress test tells lenders whether or not you could handle mortgage payments if interest rates were higher. 

Why Have A Stress Test?

- These new rules are designed to prevent Canadians from taking on mortgages that they cannot afford.The idea is, the stress test will filter out those who might be able to buy now but would end up in foreclosure if interest rates rose at all. In theory, this would protect Canada from experiencing a financial crisis similar to the one that happened in the US in 2008.

Dampening effect on the market

This government initiative is meant to cool the highly expensive housing markets in Canada. Especially in hot markets like Toronto and Vancouver. With fewer people being able to purchase homes, we should expect some of the rising prices nationwide to cool. With a substantial decline in homebuyers ability to afford mortgages, we could expect as much as 10 to 20 percent decline in housing prices, according to James Laird, co-founder of Ratehub. Some analysts predict that Canadian mortgages will drop as much as 28% nationwide by 2020. For some, it may be advantageous to wait, increase your credit score, and then buy when the time is right.

How Does This Affect You?

Home buyers who are paying less than 20% on their mortgage will have to take this new stress test (but even those who are able to put down a 20% down payment may find themselves becoming disqualified for a home mortgage).The test determines whether you would be able to make payments if interest rates were going to increase. So, if you're someone who qualifies for the best possible interest rate at 2.94%, the stress test requires that you can handle payments at an interest rate of 5.14%. In other words, you have to qualify for a mortgage at the Bank of Canada qualifying rate. This creates a buffer between the rate you're being offered and the rates that you might be paying in the future. It's actually a pretty great tool for protecting your investment.

However, for Canadians looking to purchase their first home, it can cause some confusion. It's difficult to know what your budget is now, and what houses you can afford. Where do you start looking? Can you even afford to buy in the area you want? Knowing your stress test limits will answer all of these questions.

Do You Make The Stress Test Cut?

Luckily, the CMHC has a calculator that will give you the stress test results. You'll be able to see what your approximate budget would be for purchasing a new home. You can check that calculator out here: mortgage affordability calculator.

If you're in the market, make sure you check this calculator before you go looking at homes. It will give you the budget you should aim for and help you pass the mortgage application process much easier.

The Best Way To Afford a Home Mortgage in Canada

Take time to research and identify things like competitive interest rates, your mortgage-to-income ratio, and different ways you can increase your credit score before you sign the dotted line on your new mortgage. There are numerous financial benefits to renting and saving up before you decide to buy.

Related Article: Read our guide on “How To Prepare Financially for Buying a Home” to learn the best method for becoming a homeowner.

If you have a poor credit history, it is important to increase your rating. This way, you can avoid paying an exceedingly high interest rate. The lower your score, the more you will pay over the lifetime of that agreement.

Buying a home is one of the most rewarding purchases you’ll ever make. Stay informed and continue reading these blogs. You are already separating yourself from the large percentage of uninformed buyers in the marketplace

Do Mortgage Helpers (Legal Suites) Count With The New Stress Test?

Mortgage helpers are a legal suite in the home you plan on buying that you can rent out, bringing in extra income to help pay your mortgage. Homebuyers have been jumping on homes with suites for this reason for years. Many people choose to purchase a home with a rental suite and move in with their in-laws or just rent it out to someone local. This strategy has enabled Canadians to increase the budget of their home purchase when they take into account rental income from the suite.

So, is buying a home with a mortgage helper the perfect way around the stress test? After all, the test is based on your income and the rent you collect on the suite is surely income, right? If you make $50,000 per year and you plan to rent your suite out at $800/month, that’s another $9600 per year to increase your income… right?

Well, not exactly. Since the stress test is designed to ensure you can make your payments even in the event that interest rates rise dramatically, the Canadian government is looking at this realistically. If you have a rental suite in your home, there is a chance it’ll be empty at least a portion of the time. Even if you plan to have family live in it and rent it from you, life happens and plans can change. Realistically speaking, you may not be able to count on that income 100% of the time.

It’s because rental income from mortgage helpers is not a secure thing, that the stress test only allows for the inclusion of 50% of the income you estimate to earn from your rental. It’s just one more way the stress test, albeit a royal pain in the neck, is protecting you from getting in over your head.

Homes with mortgage helpers (legal suites) tend to cost a great deal more that single-family homes, so before you start looking at them as your way around the mortgage stress test, take this into consideration. If you find yourself with an empty suite and are having difficulty renting it out, you’re still on the hook for a much more expensive mortgage than you would have if you’d bought a home without a suite.

Why The New Mortgage Rules Could Be A Good Thing

Now, more than ever before, Canadians feel discouraged to jump into the housing market, but is it possible there are silver linings to this cloud? Could there be an upside to the new rules Bill Morneau has implemented to protect the Canadian economy? I would argue that yes, there are some good things that will come as a result of these new rules. Here are just a few to mull over before you get too discouraged:

Housing prices are likely to fall

If average Canadian families are no longer qualifying for average Canadian home prices, homes won’t sell unless those prices drop. Be patient and wait to see what happens to the housing prices around you in a few months. You may be pleasantly surprised.

If average Canadian families are no longer qualifying for average Canadian home prices, homes won’t sell unless those prices drop. Be patient and wait to see what happens to the housing prices around you in a few months. You may be pleasantly surprised.

You could potentially afford a nicer home for less

If you were in the market before the new rules came into effect, you were probably looking at houses that are no longer priced near what you might qualify for now. But, if prices drop, you might find yourself looking at exactly those homes again, but for much less. You’ll be living well within your means, in a new home you love.

You’re much less likely to get yourself in any trouble

The new stress test for mortgages checks to see if you would qualify for a mortgage at nearly two whole percentage points higher than what you’re likely to get your actual mortgage for. That’s a whole lot of wiggle room, and it means you’ll be able to keep paying your mortgage and keep possession of your home even if adversity strikes. You’re also going to be pocketing a whole lot more dough each month, as your mortgage payments will be lower. Imagine what you could do in a few years if you saved the difference every month!

It is possible the rules might be tweaked over time

In the aftermath of implementing these rules, many Canadians have protested. MPs across the country have been receiving countless letters from average, middle-class Canadians who have been priced out of buying their first home. Government representatives have also been hearing from mortgage brokers, financial advisors, and other financial professionals. The message is that these rules are too harsh and make it virtually impossible for middle-class Canadian families to buy homes in today’s market. The government is under heavy pressure to reconsider the 4.64% mark and to perhaps bring it down to a more reasonable rate. If Bill Morneau feels this heat and drops the percentage for the stress test, you might find yourself back on the market and able to buy.

If you’re a Canadian who was hoping to buy his first home before these rules hit, and now you’re not so sure, just wait it out for a bit. Put your down payment in a high-interest savings  account, and put off your plan to purchase for just a few months. It is all but guaranteed things will keep changing over the next couple of months, as we know that other proposed rules have been put off while talks and considerations take place. Some of these changes could be in your favour.

So, before you apply for a German work visa, consider the fact that enabling Canadians to purchase homes is one of the biggest cogs in the machine that keeps our economy afloat. It is in everyone’s best interest that Canadians keep purchasing houses. In time, the kinks will all be ironed out and you might be in a better position to buy than you ever thought possible before.

In the meantime, remember the old cliche, “if it bleeds, it leads”. While there is no physical wound here to report on, the media loves a good fear-inducing story. You will read more doom and gloom in the coming months, but that says more about the suffering news industry than it does about your ability to eventually purchase a home.

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Do you know how high your credit score should be in order to get approved for a mortgage? Check out this post to find out! What can you do if your score isn't high enough? Refresh Financial has a cash secured loan which is one of the best ways to increase your credit score!