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Updated
Financial institutions evaluate a borrower’s ability to repay a mortgage loan under different circumstances, including potential interest rate increases, using a mortgage stress test.
This test typically involves calculating the borrower's debt-to-income ratio and evaluating their ability to make mortgage payments at a higher interest rate than the current one.
The purpose of the stress test is to ensure that borrowers are not taking on more debt than they can handle based on their income, and to reduce the risk of default for both the bank or lender and the borrower.
The mortgage stress test is calculated by examining the borrower's financial situation such as income, car debt, other rental expenses, day-to-day expenses, etc. and determining their ability to make mortgage payments under various scenarios.
The most common way to calculate the stress test is to use the higher of 5.25% or the contractual mortgage rate plus 2%.
For instance, a borrower has a contractual mortgage rate of 3%, the lender will use 5.25% or the contractual mortgage rate plus 2%, whichever is higher. They will evaluate whether the borrower can make their mortgage payments at the contractual rate of 3% and the higher stress test rate of 3% + 2% = 5%, as well as 5.25%.
If the borrower can afford the payments at both rates, they pass the stress test. However, if they cannot afford the payments at the higher rate, the lender may reduce the mortgage amount or require the borrower to provide a co-signer or a larger down payment to mitigate the risk.
RATESDOTCA’s new mortgage stress test calculator is a user-friendly and straightforward tool which gives you desired results by providing basic information such as purchase price, interest rate, amortization period and down payment.
In a few effortless steps you can assess your mortgage affordability with our stress test calculator and get a clear picture of your financial position.
Here’s a step-by-step guide to help you use this tool:
Enter the Purchase Price: This is the total cost of the property you're planning to buy.
Enter the Down Payment: This is the amount of money you're putting down upfront to buy the property. Ideally, you want to put down at least 20% of the purchase price to avoid paying mortgage insurance premiums. A buyer purchasing a property over $1 million must pay 20% down payment.
Enter the Amortization: This is the length of time it will take to pay off the mortgage in full. Common amortization periods are 25 or 30 years.
Enter the Mortgage Rate: This is the interest rate you'll be paying on your mortgage. You can find this rate by checking with your lender or mortgage broker.
Enter the Payment Frequency: This is the frequency with which you'll make mortgage payments. Common payment frequencies are monthly, bi-weekly, or weekly.
Once you've entered all the required information, the mortgage stress test calculator will automatically generate the results.
The calculator will provide you with the Payment Amount, which is the amount you'll be paying each payment period to pay off your mortgage.
The calculator will also provide you with the Payment Amount used for qualification, which is the amount that the lender will use to determine whether you qualify for the mortgage.
Finally, the calculator will provide you with the Stress Test Rate, which is the higher of 5.25% or your mortgage rate plus 2%. This rate is used to determine whether you can afford to make mortgage payments at a higher interest rate.
To achieve your desired results using the calculator, you can play around with the different input variables to see how they affect the results. For example, you can adjust the down payment amount to see how it impacts the stress test rate or adjust the amortization period to see how it affects the payment amount. By doing so, you can find the combination of variables that works best for your financial situation and helps you pass the mortgage stress test.
If you're planning to take a mortgage and want to ensure that you pass the stress test, here are some steps you can take:
Starting June 1, 2021, mortgage applicants who pay a down payment of 20% must qualify for stress test just as those borrowers who pay a down payment between 5% to 19% of purchase price. The Bank of Canada's benchmark qualifying rate, which is updated weekly, is 5.25%.
As per the Bank of Canada, the benchmark qualifying rate is 5.25%. This means that if your contractual mortgage rate was 3%, the stress test rate would be 3% + 2% = 5%. However, if the benchmark qualifying rate was higher than your contractual rate plus 2%, the stress test rate would be the benchmark qualifying rate.
It's important to note that the mortgage stress test rate can change over time based on market conditions and other factors, so it's essential to stay informed about the current rate when you're planning to apply for a mortgage.
If a borrower fails mortgage stress test, they must re-evaluate their financial condition and house search criteria.
They may need to consider reducing the amount they plan to borrow, either by increasing their down payment or looking for a more affordable home. Alternatively, they may need to improve their credit score or reduce their debts before reapplying for a mortgage.
If someone cannot qualify for a mortgage even after taking these steps, they may need to delay their plans to buy a home or consider alternative options, such as renting or co-owning a property with family or friends.
Failing the mortgage stress test does not necessarily mean that someone cannot afford a home altogether, but rather that they may need to adjust their expectations or take steps to improve their financial situation before applying for a mortgage again.
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