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Ever since 2018, Canadian real estate buyers are required to go through the OSFI Mortgage Stress Test, regardless of the size of their down payment while going through federally regulated lenders. This can seem discouraging, as the buyer’s finances are more closely judged before receiving their approval. However, this test is simply conducted to prove a buyer’s ability to make their mortgage payments, regardless of rising interest rates.
So, how will the mortgage stress test impact Canadians in 2022 and beyond? Let’s look at how it works and its impact on homebuyers.
However, before we dive in, if you would like to ensure that your finances are properly prepared for the stress test, click the link below to book a free strategy call to discuss how you can qualify for the best rate today.
What is the OSFI Mortgage Stress Test?
The Office of the Superintendent of Financial Institutions (OFSI) Mortgage Stress Test is pretty much exactly what it sounds like. It is a test to make sure the buyer will be able to continue making mortgage payments during times of financial stress, such as unexpectedly losing employment. This test puts the buyer’s finances up against a minimum “qualifying rate” to ensure that changing circumstances do not change their ability to afford a mortgage.
New Stress Test Rules – June 2021
Starting in June 2021, the rules of the stress test have been updated. Now, to qualify for a mortgage, the buyer must be able to prove they qualify at their contracted mortgage rate plus 2 per cent or 5.25 per cent, which is a benchmark used to qualify insured and uninsured mortgages. Buyers applying for rates below 3.25 per cent must use the 5.25 per cent benchmark, while buyers applying over that amount must use the contracted rate plus 2 per cent because it is a higher rate.
Due to this stress test, the purchasing power buyers held has been cut down by as much as 20 per cent because they now only qualify for lower overall amounts at the new rates. This has also made it difficult for new homeowners who are looking to refinance or renew their mortgages.
Prior to this, the rate was 4.79 per cent or the borrower’s rate, whichever was higher, for uninsured mortgages. Meanwhile for insured mortgages, the rate was 4.79 per cent or the borrower’s rate plus 2 per cent, depending on which rate was higher.
Can the Stress Test Be Avoided?
The stress test is meant for banks and lenders under federal jurisdiction. This means private or provincially regulated lenders are not required to make their borrowers undergo the test, However, it may still be advantageous for them to consider their mortgages under the same lens as the stress test for the sake of their own financial safety and security. It is also important to not non-traditional lenders often charge higher interest rates, offsetting their easier qualification standards.
What to Consider When Applying for a Mortgage
There are a few things to consider when applying for a mortgage that will come up while undergoing the stress test. Taking the time to consider these factors beforehand can help potential buyers know what to expect.
How Much Has Been Saved for a Down Payment?
Buyers will have to take the stress test regardless of whether they have 20 per cent saved for a down payment. However, it is still useful to consider how much has been saved to determine how large of a mortgage they can afford to get.
What Interest Rates Are Being Offered?
Getting pre-approved for a mortgage can help the borrower determine what mortgage rate they will be able to secure. This can help the buyer figure out how much they can afford each month in mortgage payments.
Is a Rate Increase Affordable?
The entire point of the stress test is to determine whether a buyer can afford to continue paying their mortgage in the event of increased rates or financial difficulty. So, it can be useful for them to take their budget and compare it against a rate increase of 2 per cent or a total rate of 5.25 per cent, much like the stress test will.
Discover How To Apply For An Investment Property Mortgages With This Step By Step Guide
Preparing for The Mortgage Stress Test
Generally, there is very little that can be done about the benchmark rate and the rate the lender is charging on the mortgage. However, it can still be helpful to consider what can be done to increase the likelihood of passing the stress test. To do so, here are some factors to consider while going over one’s finances.
The Size of The Loan
It is important to be realistic about how much is affordable when applying for a mortgage.
While expensive houses can be appealing, they may not be reasonable when it comes time to repay a mortgage. It is very important to properly consider how much can be reasonably repaid, before winding up bogged down in debt.
Paying Down Debt
Lenders will look at the amount of debt currently being carried by a potential borrower and factor it into their eligibility for a mortgage. Paying down debts will not only make it easier to pass the mortgage stress test, but also increase the borrower’s eligibility to obtain a mortgage in the first place.
Gross Debt Service Ratio (GDS)
A person’s GDS represents the percentage of their pre-tax income that would be required to pay all their housing costs. This includes charges such as utilities, property taxes and condo fees (if applicable).
Each of these costs will be added together and divided by the person’s gross monthly income. Lenders are looking for this percentage to ideally be no higher than 32 per cent.
Total Debt Service Ratio (TDS)
All a person’s debts are factored into their TDS. This includes student loans, credit cards, personal loans, car payments and so forth. These debts should total no more than 42 per cent of a person’s gross income to be prepared.
Crunching the Numbers
The mortgage stress test is designed to make sure homeowners aren’t blindsided by unexpected increases in mortgage payments. This is especially important for people with variable interest rates, who would be immediately impacted by an increase.
Buyers need to consider whether an increase from $1000 to $1200 a month would be manageable or throw them into financial chaos. This way everyone can be sure that monthly payments would continue in-full and there is no concern about defaulting on the loan.
The Future of The Canadian Mortgage Stress Test
The strict nature of the mortgage stress test has caused many applicants to feel the harsh reduction in their buying power. This has led many to pressure the OSFI into considering easing the rules for the test. The rules were introduced to slow the housing market to ease rapid price increases, however some suggest these rules are too harsh.
However, since the introduction of stricter rules for the test, many markets have cooled down following rising interest rates. This has prompted the OSFI to review the rules, but as things stand nothing has changed yet.
Understanding the mortgage stress test begins by knowing your interest rate. To secure the best possible rate, it is important to seek pre-approval from experienced lenders. To get started visit LendCity.ca or call (519)-960-0370 Alternatively, you can click the link below for a free strategy call today.