The mortgage stress test has transformed home affordability and purchasing power for an entire generation of Canadian homebuyers. Implemented nationally in 2018, it is now engrained as a mandatory component of the mortgage approval process.
This in-depth guide aims to provide homebuyers, owners, and advisors with the most comprehensive overview of the stress test. We will cover:
- What is the mortgage stress test? When is it applied?
- The impacts of mortgage stress test
- Options if you can’t pass the mortgage stress test
- Tips for preparing for the stress test or to avoid it
Read on for clarity on how the stress test works and how to best prepare when buying your home.
What is a Mortgage Stress Test?
The mortgage stress test is the mortgage rate qualification rule under OSFI Guideline B-20, which requires homebuyers to qualify for a mortgage at an interest rate higher than they will actually pay. This is done to buffer for future rate increases that may occur over the mortgage term.
When applying for a mortgage, the stress test interest rate is determined as follows:
- Determine your contracted mortgage interest rate offered by the lender
- Add two percentage points to that contracted rate
- Compare the sum to the current stress test minimum rate set by OSFI, currently at 5.25%
- The higher of the two rates is your stress test rate
(Source: https://www.osfi-bsif.gc.ca/en/guidance/guidance-library/minimum-qualifying-rate-letter-2021)
For example:
- If your contracted rate is 4.55%, your stress test rate is 4.55% + 2% = 6.55%
- If your contracted rate is 5.10%, stress test rate is 5.10% + 2% = 7.10%
- In both cases, the calculated rate exceeds the 5.25% minimum, so the higher calculated rate is used.
This higher stress test rate determines the maximum mortgage amount and home price a buyer can qualify for.
By testing mortgage affordability at a hypothetical higher rate, borrowers are proven to have a cushion in case rates rise in future before they renew.
This promotes responsible borrowing by preventing Canadians from taking on excessive housing debt relative to income, thus protecting both the lender and borrower.
When is the Mortgage Stress Test Applied in Canada?
The stress test is applied to most situations – purchasing a home, refinancing, switching lenders, and taking out a HELOC. Renewing with the same lender is exempt.
- Purchasing a Home: All borrowers are stress tested when purchasing a home, whether making a down payment above or below 20% of the price.
- Mortgage Refinancing: Borrowers must redo the stress test when refinancing an existing mortgage, whether with their current or new lender.
- Switching Mortgage Lenders: A stress test applies if you switch your existing mortgage to a new lender unless you are renewing an insured mortgage, as outlined below.
- Obtaining a HELOC: Taking out a new home equity line of credit requires passing the stress test again.
- Renewing with Existing Lender: An exception – borrowers can renew for a new mortgage term with their existing lender without undergoing another stress test.
- Renewing and Switching Lenders: There is a stress test policy for borrowers who switch lenders at renewal time.
- Uninsured mortgages (down payment over 20%) MUST redo the stress test when switching lenders on renewal.
- Insured mortgages (down payment under 20%) do NOT require re-testing when switching lenders at renewal.
This nuance is due to the insured status keeping risk with the mortgage insurer.
How Does the Mortgage Stress Test Impact Mortgage Affordability?
By testing repayment ability at higher interest rates, the stress test reduces the maximum mortgage amount and home price a borrower can qualify for. For example:
| Without Stress Test | With Stress Test | |
| Mortgage Rate | 4.5% | 6.5% |
| Home Purchase Price | $500,000 | $430,000 |
| Down Payment (20%) | $100,000 | $86,000 |
| Mortgage Required | $400,000 | $344,000 |
In this example, the stress test rate increases the required down payment amount by $14,000 and decreases the maximum qualified home price by $70,000 for this hypothetical buyer.
When tested at a lower rate, their income can support a higher-priced home. But under the stress test, buyers are forced to opt for a lower-priced property or save a larger down payment.
How are your Maximum Mortgage amounts determined?
Lenders determine maximum mortgage amounts and home prices borrowers qualify for using two key debt service ratios – GDS and TDS:
Gross Debt Service (GDS) Ratio
The GDS measures total housing costs divided by gross household income. As a rule of thumb, the GDS should not exceed 32% for insured mortgages or 39% for conventional mortgages.
Total Debt Service (TDS) Ratio
The TDS measures total debt obligations divided by gross household income. This includes housing costs plus all other debts, such as car loans and credit cards. The TDS limit is typically 44%, but it depends on individual factors.
When applying the stress test, lenders determine these ratios based on the higher stress test interest rate. This constricts the maximum mortgage amount the borrower is deemed to comfortably support.
Mortgage Stress Test for First-time Home Buyers
The stress test can significantly impact the purchasing power of first-time home buyers. Consider the following:
- First-time buyers have smaller down payments, relying heavily on insured mortgages
- Their average down payment was just 8% of the purchase price in 2023.
- But they must still qualify at much higher stress test rates with these smaller down payments
The impact is that some first-time buyers may be priced entirely out of the market, and others must settle for far lower-priced properties than expected. If possible, making larger down payments can help ease the stress test burden.
For other buyers, the stress test may push affordable home prices much lower than expected. Coming up with a larger down payment is an option but can be difficult to accumulate, leading to frustration.
Critics argue the stress test has made home ownership unattainable for many younger Canadians looking to enter the market. However, regulators still see strong value in maintaining responsible lending standards.
This necessitates very large mortgages relative to incomes for new entrants while applying stringent stress test qualification criteria.
How to Evaluate Stress Test Readiness Before Applying?
Prospective buyers can evaluate their mortgage eligibility and stress test readiness in 3 ways before actual application:
- Online Mortgage Affordability Calculators
Various tools allow inputting personal financial scenarios to estimate maximum approval amounts and required down payments.
- Mortgage Pre-Approval with Broker
Reputable brokers offer pre-approvals to assess affordability and provide the maximum mortgage you qualify for.
- Review Budgets and Credit
Buyers should optimize their budget and credit score before applying, as both impact rates offered and stress test outcomes.
Getting pre-approved provides the most reliable estimate of the stress test’s approval amount and qualification.
Do NOT Pass the Mortgage Stress Test – What to do?
For hopeful buyers who don’t qualify for their desired mortgage amount under the stress test, there are some options:
- Increase Down Payment
Contributing more upfront lowers the mortgage required. This improves the chances of meeting debt ratios at higher stress test rates.
- Improve Credit Score
A higher score qualifies borrowers for lower interest rates. Since the stress test rate is a set premium above the contract rate, improving credit to get better contract rates makes passing the stress test easier.
- Purchase Lower Priced Property
Opting for a less expensive property lowers borrowers’ required mortgage amount to qualify for.
- Alternative Lenders
Certain credit unions or private lenders may provide mortgages without requiring the federally mandated stress test.
Coming up with a larger down payment through added savings, gifts, or other means is generally the simplest option. The lower mortgage required will increase the chances of qualifying under the strict stress test.
How to Avoid the Mortgage Stress Test?
While difficult, some limited scenarios exist where borrowers can avoid the stress test:
- Renew with Existing Lender
Mortgage renewal with an existing insured or uninsured lender does not require another stress test.
- Provincially Regulated Lenders
Some smaller credit unions not overseen by OSFI may have stress test exemptions, especially for borrowers with 20%+ down payments.
- Alternative/Private Lenders
Unregulated lenders like mortgage investment corporations may offer mortgages without requiring the stress test.
- Larger Down Payment
A down payment of at least 20% opens access to credit unions and alternative lenders who may waive the stress test for uninsured mortgages.
However, most buyers must pass it when dealing with mainstream regulated lenders. The simplest ways to avoid the test are to have a larger down payment or renew with your existing lender.
How does Mortgage Stress Test Differ for Refinancing vs. Renewals?
Refinancing a Mortgage
Borrowers must complete a new stress test when refinancing, regardless of staying with their existing lender or seeking a new lender. Refinancing is subject to full re-underwriting.
Renewing with Existing Lender
If you are simply renewing a mortgage with the existing lender, no stress test is required. It is exempt unless other parameters, like the amortization period, change.
Renewing and Switching Lenders
As outlined earlier, only uninsured mortgages (down payment over 20%) must redo the stress test when switching lenders on renewal.
Insured mortgages (down payment under 20%) are exempted from stress testing when switching lenders at renewal. The mortgage insurer retains risk.
Criticism and Calls for Changes to the Stress Test
While now an accepted part of the mortgage market, the mortgage stress test has drawn criticism and calls for reform from various groups:
- Housing advocates argue it harms affordability and prevents market entry, especially for younger first-time buyers with limited down payment savings.
- Mortgage industry stakeholders say it restricts refinancing and lender switches, limiting competition and consumer choice.
- Regulators believe it remains a necessary prudence measure and have not publicly indicated plans to eliminate it. They are open to moderate tweaks to improve flexibility.
With higher interest rates in our minds today, the prudence of testing repayment ability at higher qualifying rates is newly justified. It remains contentious, but the merits continue to outweigh critics’ concerns for policymakers.
Potential Future Policy Changes
While not expected to be abolished, there are certain potential changes policymakers are considering for the stress test policy:
Waiving Stress Test for Uninsured Renewals
This would exempt borrowers who switch lenders at renewal but have 20%+ equity from redoing the stress test. Proponents argue this encourages competition between lenders.
However, Canada’s banking regulator indicated there would be no imminent changes to the stress test requirements despite acknowledging that the mortgage stress test is applied unequally to certain homeowners renewing their mortgages.
Introducing a Maximum Loan-to-Income Ratio
An additional ratio measuring total debt against income would complement today’s GDS and TDS ratios in assessing affordability.
Updating the Minimum Qualifying Rate More Frequently
OSFI reviews the defined minimum stress test rate annually. More frequent adjustments could allow it to better track market shifts.
Overall, significant changes are viewed as unlikely in the near term. Modest adjustments may be implemented to balance prudence and flexibility amidst critics and advocates.
Key takeaways: Preparing for the Canada Mortgage Stress Test
The mortgage stress test is an established pillar of the home financing process, impacting millions of buyers. All prospective borrowers should understand the key aspects:
- Required by all mainstream regulated lenders when financing a home
- Reduces maximum mortgage amount by testing on higher hypothetical rate
- It can be very restrictive for first-time buyers with smaller down payments
- Work on improving credit, budgeting, and down payment savings before applying
- Get pre-approved to both confirm the true maximum amount and prepare documentation
While some criticism remains, understanding and preparing for Canada’s mortgage stress test is crucial to navigating the market and financing landscape for today’s home buyers. The test has transformed housing affordability and requires proactive planning to overcome its stringent effects.
By understanding the policy and its rationale, you can best prepare yourself and work with mortgage advisors to craft strategies for maximizing affordability and overcoming the stress test on your home-buying journey.
FAQs
How is stress test rate calculated?
It is the greater of the borrower's contracted rate + 2% or the OSFI minimum stress test rate, currently 5.25%.
How does mortgage stress test impact maximum borrowing?
It lowers the maximum mortgage amount and purchase price qualified for by testing affordability at a higher rate.
First-time home buyers affected most by stress test?
Yes, first timers with smaller down payments rely on insured mortgages but must still meet stringent stress test criteria.
What if you can't pass the stress test?
Options include a larger down payment, improving credit score, buying a lower priced property, or seeking alternative lenders.
Can borrowers avoid stress test?
Difficult, but possible by renewing with the same lender, provincially regulated lenders, private lenders, or 20%+ down.
Does mortgage stress test apply to refinancing?
Yes, it is required when refinancing a mortgage regardless of using existing or new lender.
How can you prepare for the stress test?
Improve credit, budget, down payment savings. Get pre-approved to confirm maximum borrowing.
Will the stress test be changed or removed?
Unlikely to be abolished but moderate tweaks are under consideration to improve flexibility.