Canada's Office of the Superintendent of Financial Institutions (OSFI) introduced a "mortgage stress test" that went into effect in January 2018. The test is meant to prevent homebuyers across the country from getting into financial trouble. The mortgage stress test may have outlived its usefulness, however. Some industry experts say it is preventing up to 10 percent of homebuyers from buying when they could afford today's mortgage rates in Canada without the additional financial qualifications.
What is the Mortgage Stress Test?
When banks consider lending for any reason, a "stress test" is a general principle applied to determine if a borrower can still repay a loan if interest rates increase. "Stress tests" also consider whether the borrower can still repay the loan if their income is temporarily reduced. Prior to January 2018, the mortgage stress test was only used for insured mortgages where buyers put less than 20 percent down on a home.
OSFI's mortgage stress test now applies to any mortgage loan issued by a federally regulated bank in Canada. Borrowers must be able to qualify not only for the rate negotiated in their mortgage contract but also that rate plus an additional two percent or the average five-year conventional mortgage lending rate, whichever is greater. The five-year benchmark rate is evaluated monthly and was 5.34% in January and February 2019. Credit unions, which are provincially regulated, don't have to use the test, but some of them are voluntarily using OSFI's guidelines.
Lenders use two calculations to determine whether borrowers can safely repay a mortgage. The first calculation is the gross debt service ratio (GDS). After the bank determines the stress-tested mortgage payment, they add property taxes, half of homeowners' association dues or condo fees, and heating costs. They divide this amount into your monthly before-tax income. A GDS ratio of 30 to 32 percent will qualify you for a stress-tested loan.
A second ratio considered by lenders is the total debt service ratio (TDS). Your monthly debt payments, including credit cards and car loans, are added to the GDS amount and divided into your monthly income. The resulting TDS ratio shouldn't rise above 44 percent of your monthly pre-tax pay. Auto loans are monthly payments that can increase the TDS ratio, so it's wise to seek the most affordable car loan even if you're not currently in the market for a home mortgage.
Who is the Mortgage Stress Test Affecting?
The mortgage stress test reduces home-buying power. If you've pre-qualified for a $300,000 mortgage, the mortgage stress test will reduce the amount you qualify for by a minimum of 18.5 percent. The stress test mortgage you can qualify for will be $244,500. If you've been pre-approved for a $700,000 loan, the stress test will reduce the amount of mortgage you can qualify for to $570,500.
Buyers at the highest risk of failing to qualify for a mortgage so far are those who are shopping for a home at the limit of their buying ability. First-time homebuyers and condo buyers in markets like Toronto and the rest of the GTA are running into trouble, especially because condo and association fees figure into debt service ratios. The Canadian Real Estate Association and regional associations have asked for the mortgage stress test to be re-evaluated because at least 10 percent of homebuyers are failing the test who would have qualified before the rules took effect.
You can reduce your GDS/TDS ratio by putting down a higher down payment, increasing your monthly gross income, or reducing your current debt payments. Use Rates.ca's credit card comparison tool to get the best rates on credit cards. Use Rates.ca's mortgage rate tool to determine rates and shop for the best mortgage. Rates.ca's guidelines for getting or renewing a mortgage also provide helpful tips.