Essential facts to understand about the mortgage qualifying rate
What is a mortgage stress test?
A mortgage stress test is the qualifying benchmark set by the Canadian government’s Office of the Superintendent of Financial Institutions (OSFI) to reduce risks to the housing market, such as mortgage default risk. The Minister of Finance is responsible for setting mortgage stress test rate for insured mortgages and OSFI sets the mortgage stress test rate for uninsured mortgages.
The reason to set a mortgage stress test is due to fluctuating interest rates, one of the few factors that can affect the cost of buying a house. The mortgage rate is one of the biggest reasons the cost of a home may increase, particularly if you use a variable-rate mortgage, which is linked to Bank of Canada rates and rise and fall based on the bank rates.
Previously set at 4.79%, the mortgage stress test rate was revised in June and is applicable to all mortgages, both uninsured and insured (homes bought with down payments less than 20%). To make sure you will be able to afford any possible mortgage cost spikes, the mortgage stress test rate is higher than the lending rate you would get from a financial institution.
How does it work?
A mortgage stress test is a high interest rate on a mortgage application that a bank or a mortgage broker uses to qualify you. Essentially, a mortgage stress test is a rate that is raised artificially in order to lessen the amount of mortgage for which you may qualify, rather than acting as a real interest rate viewable on – for instance – your mortgage approval document, or that your payments could be based on.
Typically, the stress test rate could lower your mortgage approval by roughly 20%. For instance, if you qualified for a $500,000 mortgage with an interest rate of 2.25% for a 5-year period, the maximum mortgage you could qualify for may be lowered to $400,000 if you use the stress test rate of 5.25%. Put simply, your mortgage approval would be reduced by roughly $100,000 if you qualified at 5.25% versus the contract rate of 2.25%.
What is the purpose of stress test?
The purpose of a mortgage stress test, initially, was to prevent potential homebuyers from taking out a mortgage that was too costly for them, and therefore getting themselves into even worse debt and contributing to Canada’s household debt problem. Since the average Canadian household is indebted up to 170% of their disposable income, Canadians owe $1.70 after taxes for each dollar they earn. Many potential homebuyers would be unable to afford their homes in the years to come, due to the gradual rise of interest rates and housing nation-wide.
Since this was becoming an issue, the Office of the Superintendent of Financial Institutions, or OSFI, proposed changes to housing and mortgage rules in Canada in July of 2016. One of those proposed changes included implementing a mandatory mortgage stress test for future homebuyers who borrow from banks, or other federally regulated lenders.
Initially the mortgage stress test applied only to those people who were looking for high-ratio mortgages, i.e., for people who were making up to 20% down payments and who had to therefore pay mortgage default insurance premiums. It also included homebuyers with a mortgage term of less than 5 years. As of October 17, 2017, however, all potential homeowners had to take the mortgage stress test, even anyone applying for conventional uninsured mortgages (i.e., paying a down payment higher than 20%).
What is the current stress test rate?
Previously set at 4.79%, the mortgage stress test rate was revised in June of 2021 and now applies to all mortgages, including uninsured mortgages and insured mortgages. To make sure you as a potential homebuyer can make payments despite possible increases to mortgage costs, the mortgage stress test rate is more than the actual lending rate you might get from the financial institution. In June, 2021, the Office of the Superintendent of Financial Institutions Canada, or OSFI, set the new mortgage stress test rate for uninsured mortgages at 5.25%, or your current interest rate plus 2% – whichever is higher.
Can I get a mortgage without a stress test?
Since the mortgage stress test was designed for federally regulated banks, private lenders or provincially regulated lenders are not under the jurisdiction of OSFI. Unlike federally regulated lenders like traditional banks, private or provincially regulated lenders are not required to put mortgage applicants through a stress test and are generally more flexible in their lending requirements (say, for instance, if you are self-employed or have a poor credit score). The downside in taking that route is that private mortgages come with significantly higher mortgage rates, in some cases more than 10%.