Are you currently on your home searching journey or have considered starting? If the answer is ‘yes’, then the topic of mortgages has most likely come up, along with the new stress test. But what exactly is it and how can it effect you?
Don’t worry, we’re here to help!
What is the Mortgage Stress Test?
For many homebuyers obtaining a mortgage is very common and necessary. When applying, financial institutions take into consideration factors such as one’s credit score, annual income, and existing debts to determine the maximum amount they can borrow and at what contractual interest rate. However, this interest rate is not the rate used by these institutions to determine one’s eligibility. Instead, a higher rate is used, and this is known as the stress test.
Implemented in 2018 by the Office of the Superintendent of Financial Institutions (OFSI), its purpose is to protect borrowers. Most mortgages in Canada now are limited to a 25-year amortization period. This means that 25 years is the amount of time a borrower will need to pay off their mortgages, but it also means that your rates can increase with each renewal term during this 25-year span as well. Simply put: the higher the interest rate, the higher the monthly mortgage payments.
The stress test is, therefore, needed to ensure that borrowers can continue to afford their payments if/when these higher rates come into effect. By doing so, this lowers the chance for borrowers, like you and I, to be forced to default on our future payments or, even worse, lose our home all together.
This test was initially only applied to high-ratio mortgages (down payments of less than 20% of the purchase price), but now applies to all mortgages; uninsured and insured mortgages.
How Does it Work?
In order to pass the stress test, financial institutions will apply one of the following two rates to determine your eligibility – whichever is higher:
- Contract rate plus 2%
- Bank of Canada’s five-year benchmark rate
In a sense, this operates like a ‘worst case scenario’. In case you lose your income, increase your debts, or have your interest rates increased, you would still be able to afford your mortgage payments.
New Mortgage Stress Test
Increasing from the previous benchmark rate of 4.79%, the new stress test has been amended to the following as of June 1st, 2021:
- Contract rate plus 2%
With this increased benchmark rate, homebuyers looking to qualify for a mortgage after June 1st, 2021 will be faced with decreased purchasing power as it reduces the amount they can borrow compared to before. However, those that have pre-approved mortgages prior to this date will maintain their prior rates and qualified amounts up until their pre-approval deadline.
While this could sound disheartening for some, especially for first time homebuyers, the hope is that this new stress test will help cool down the housing market and result in less competitive bidding wars.
If you expect that you will require financing for your next home purchase, you should consult your preferred bank/mortgage specialist as soon as possible.
We can then help take care of the rest! Give us a call!
Rachel Van: 778-960-2202 / [email protected]
Arthur Van: 778-822-8219 / [email protected]