How much home can you afford? If you’re looking to buy a house or refinance your mortgage, this question may be top of mind.
Your purchasing power is partly determined by what’s called a mortgage stress test.
In 2016, the Office of the Superintendent of Financial Institutions (OSFI) introduced mortgage stress tests. These tests were created to protect Canadians from taking on more debt than they could afford.
“Mortgage stress tests are like a buffer to protect your budget,” says Laura Brokopiw, a Personal Banking Advisor at Cambrian. “They are in place to ensure you can still afford payments in the event that rates increase.”
We’re sharing what you need to know about the test, with advice from Laura Brokopiw.
When you apply for a mortgage, your financial institution will offer you an interest rate—also known as your mortgage contract rate.
But if interest rates climbed over the next few years, would you still be able to make your monthly payments?
This is what a mortgage stress test sets out to answer.
A mortgage stress test will qualify your finances using a higher interest rate than what your financial institution offers you. Here’s why:
When you take out a mortgage, your interest rate will change over time.
Variable rate mortgage: If you choose a variable rate mortgage, your interest rate will fluctuate as market conditions change.
Fixed rate mortgage: With a fixed rate mortgage, your payments are locked in at one interest rate for anywhere from 6 months to 5 years. Once your mortgage is up for renewal, your financial institution will offer a new rate that reflects current market conditions.
Whether it’s in 6 months or 5 years from now, it’s safe to say that your mortgage interest rate will fluctuate.
A stress test anticipates this change. It determines whether you’ll still be able to make mortgage payments if interest rates increased.
“The last thing anyone wants is to be forced to sell their home,” says Laura. “We qualify you at a higher rate to keep your payments comfortable and affordable if rates go up.”
If you are:
Then you’ll need to pass a stress test to be approved.
If you’re renewing your mortgage with the same financial institution, you do not have to undergo a mortgage stress test again.
For the past 3 years, interest rates have been in a state of flux.
In late 2020, rates plummeted as the pandemic swept the country. The real estate market was red hot and bidding wars were the norm. Now, in 2023, interest rates are climbing back up and the market is slowing down.
“With rising interest rates, houses are selling under asking price. Stress tests help flatten out the market—in the long run, this is beneficial for consumers trying to buy houses,” says Laura.
First, your financial institution must determine your qualifying rate.
Your qualifying rate will be the greater of 5.25% or your mortgage contract rate + 2%.
Given the current rate environment, you’ll need to prove you can still pay your mortgage at an interest rate of ~7% or higher.
5.25% is the current minimum qualifying rate as set by the Office of the Superintendent of Financial Institutions. The two percentage point increase acts as a safety buffer. The OSFI reviews the rate annually, which means it’s subject to change.
Mortgage stress tests are required for both high-ratio and conventional mortgages. If you have a down payment that’s 20% or more of the home’s purchase price, you’ll still need to pass a stress test to qualify for a mortgage.
To determine if you can afford your home, financial institutions will look at two key metrics: your gross debt service ratio (GDS) and total debt service ratio (TDS).
If your GDS or TDS ratios are above industry standards, it’s less likely that you’ll qualify for a mortgage.
This ratio measures the percent of your income that will go towards monthly homeowner expenses.
It’s calculated by adding up your total monthly expenses (mortgage payments, utilities, and property taxes) and then dividing that number by your monthly income. If you’re buying a condominium, condo fees factor in as well.
To pass a mortgage stress test, the GDS ratio should fall below 39%—although some institutions have different guidelines.
Example:
Your monthly income is $5,000
Your mortgage payments are $1,000/month
Your electricity, water, and heating costs are $250/month
You pay $3,000 in property taxes each year, which breaks down to $250/month
1,000 + 250 + 250 = $1,500 of housing expenses/month
1,500 / 5,000 = 0.3 x 100 = A GDS ratio of 30%
This ratio factors in monthly homeowner expenses and any debt you may have (such as credit cards, student loans, or car payments). Again, the total is divided by your monthly income.
To pass a mortgage stress test, the resulting TDS ratio should fall below 44% (the exact number will vary based on which institution you’re borrowing from).
Example:
Your monthly income is $5,000
Your housing expenses are $1,500/month
You pay $300 for your car loan each month
Your credit card balance is $200/month
1500 + 300 + 200 = $2,000/month
2000 / 5000 = 0.4 x 100 = A TDS ratio of 40%
A stress test can reduce the mortgage loan amount that you’ll be approved for.
But that isn’t necessarily a bad thing.
“If rates increase, a stress test ensures that you’ll still be able to afford your home and have money for other expenses,” says Laura.
Having trouble qualifying for a mortgage?
“Make an offer within your means or save up a larger down payment. If need be, you may have to pay off some of your debt first and re-apply,” advises Laura.
To pass a stress test, you need to either:
Here’s what that looks like in action:
How much money are you putting down on the home? This will determine the amount of your monthly mortgage payments.
By increasing your down payment, you’ll decrease the size of your mortgage loan. You’ll reduce the amount of interest you pay by borrowing less money.
Not only will this help you pass a mortgage stress test, but it will keep more money in your pocket in the long run.
Having a hard time getting approved for a mortgage? You may be taking on a bigger mortgage than you can afford.
To find out the maximum amount you can pay for a home, try our Mortgage Affordability Calculator. This will give you a clearer picture of what your housing costs will be as a homeowner.
One way to lower your TDS ratio is to pay off any outstanding debts you have. This includes:
If debt is standing in the way of your next home, you may need to delay your timeline and work to pay it off before you can take out a mortgage.
If you’re trying to navigate the Canadian housing market, we encourage you to set up an appointment with one of our Personal Banking Advisors at Cambrian.
“Let’s see what you qualify for now, what your goals are, and what we can do to get there,” says Laura.
At Cambrian, we’re committed to offering competitive interest rates coupled with personalized member service. Book an appointment with us today!
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