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. However, a handful of years and an economy-shaking pandemic later, both homebuyers and mortgage insiders are starting to rethink some of its merits.
Some industry experts say the test was more useful before the rapid increase in interest rates to protect potential buyers from the current rate environment. Now that we’ve reached a peak, the stress test prevents many from buying — even when they can afford today's mortgage rates in Canada — due to the additional financial qualifications.
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. It also considers 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 per cent 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 per cent or the average five-year conventional mortgage lending rate (whichever is greater). The five-year benchmark rate is evaluated monthly and is currently 5.25%.
Credit unions, which are provincially regulated, don't have to use the test, but some of them voluntarily follow 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 the 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 per cent 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 per cent 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.
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The mortgage stress test reduces home-buying power. If you've pre-qualified for a mortgage, the stress test will reduce the amount you qualify for by approximately 4%, which can lower the loan you qualify for by tens of thousands of dollars.
First-time homebuyers and condo buyers in markets like Toronto and the rest of the GTA in particular running into trouble, especially because condo and association fees figure into debt service ratios.
Fortunately, 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.
But still, at the time of writing, the lowest variable rate on RATESDOTCA is 5.55%, so those qualifying for a variable rate mortgage will have to pass the test at 7.55% (their contract rate plus two per cent). Fixed rates are lower, starting at 4.24%, but still require you to pass the stress test at 6.24%.
While this may be possible for some, it’s keeping many Canadians out of the housing market. Regardless of the size of your down payment, the stress test ultimately prevents many buyers from qualifying for a mortgage at all.
The best thing you can do is continue to compare mortgage rates and work with a broker to identify what’s possible and which areas you may be able to improve to qualify for a mortgage.