If you plan to buy a home in Canada, you’ll have to pass the mortgage stress test. The mortgage stress test was introduced in 2018; this will prove that you can still pay for your mortgage even at higher rates.
A stress test helps the buyer to avoid overextending themselves. However, the stress test significantly impacts the Canadian housing market.
What is a Mortgage Stress Test?
Before proceeding to the impacts of stress tests on home buyers, let’s discuss first the definition of a mortgage stress test.
A mortgage stress test is a financial assessment that determines whether a borrower can still pay for their mortgage even after the interest rate rises in the future.
The test is based on the Bank of Canada’s qualifying rate, which is the higher of the Bank’s five-year benchmark rate or the lender’s contractual mortgage rate plus 2%. The borrower’s income, debt, and other financial obligations are also considered.
Impacts of Mortgage Stress Test
Fewer Home Buyers Qualify for Mortgages
The higher qualifying rate makes it harder for borrowers to meet the lenders’ criteria. That is why fewer home buyers can qualify for a mortgage.
According to a report by Mortgage Professionals Canada, 200,000 Canadians were prevented from buying a home because of the test.
The report also shows that first-time home buyers were the most affected by the stress test, with 40% unable to qualify for a mortgage.
Home Buyers Have to Adjust Their Expectations
Home buyers have to lower their home price range or choose a smaller home because of stress tests even after they qualify for a mortgage. It can be frustrating for home buyers who have been saving for their planned home for years.
The stress test has also increased demand for lower-priced homes, which has driven up prices in some areas.
Housing Market Slowdown
There has been a slowdown in home sales because fewer home buyers qualify for mortgages.
The slowdown has been most noticeable in areas with high home prices, such as Toronto and Vancouver.
Increased Demand for Alternative Lenders
Alternative lenders, such as private or B lenders, don’t require a mortgage stress test. But they offer higher interest rates to borrowers. Borrowers who do not qualify for traditional banks requiring stress tests go to alternative lenders to finance their homes.
Strategies to Pass the Stress Test:
Passing the stress test can be challenging, especially for first-time home buyers. Below are some strategies that may help you pass the stress test and proceed with buying your target home.
Reduce Your Debt:
Your debt-to-income ratio is crucial when it comes to passing your stress test. You have to reduce your debts to achieve a low DTI ratio. Before applying for a mortgage, make sure that you lessen your debts.
A low DTI ratio can increase your chances of getting mortgage approval.
Increase Your Income
If you have a stable job, there is a higher chance of passing the stress test. Before applying for a mortgage, you mustn’t change jobs. A steady job is determined if you are in the same position for at least two years.
If you have a low income, consider working part-time or freelancing to increase your income. This can help improve your debt-to-income ratio and increase your chance of passing the stress test.
Save for a Larger Down Payment
A larger down payment will help you pass the mortgage stress test easier. The higher your down payment, the lower amount you have to borrow. Before applying for a mortgage, consider saving up a higher amount for a down payment for a higher chance of passing the test.
Consider a Co-signer
If you are struggling to pass the stress test on your own, find a co-signer willing to take responsibility for your mortgage in case you default. A co-signer with a good reputation assures lenders that they’ll be able to cover in case of default on your mortgage.
Work with a Mortgage Broker
A mortgage broker makes your mortgage process more manageable. They have a wide range of access to lenders and can help you match with a lender that best suits you. They also have a fair share of knowledge about the stress tests and can guide you through them. Mortgage Broker can provide advice on how you can pass the test.
Be Realistic with Your Budget
Stretching yourself to the limit to buy a too-expensive home for you won’t do you any good. If you decide on a home that is beyond the budget you can afford, it will be hard to pass the stress test.
Instead, focus on finding a home that is below your budget and that you can afford comfortably. This will increase your chance of getting approved and passing the test.
Passing the mortgage stress can be challenging, especially if you are a first-time home buyer. However, there can be precautions you can take for you to be able to pass the test easily.
Knowing the impact of mortgage stress rates on Canadian home buyers and how the mortgage stress test actually works can increase your chance of passing the test. Following the above mentioned strategies will also help you pass the stress test easily.