A mortgage stress test is designed to assess whether or not borrowers can handle their payments in the event of an increase in interest rate. There are some effective strategies you can employ in order to pass this examination.
Private lenders and credit unions not governed by OSFI are likely to forego stress tests; however, you should still leave some financial cushion. Private funding options available that may not require a stress test, but you should be mindful that these also come with additional costs.
How to pass mortgage stress test is the key to a stress-free mortgage approval.
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Key Points
- A mortgage stress test evaluates a borrower’s ability to manage payments if interest rates rise, commonly calculated as either 5.25% or the actual mortgage rate +2%.
- While federally regulated lenders must administer the stress test, provincially regulated lenders like most credit unions and some private lenders may not require it.
- To pass the stress test, borrowers must maintain low debt-to-income ratios and demonstrate sufficient income to cover mortgage and other debt payments.
- The stress test has reduced the purchasing power of prospective homeowners, making it harder to buy desired homes or refinance existing mortgages.
- Alternative financing options exist for those who don’t pass the stress test, including credit unions and private lenders, but these may come with additional costs.
What Factors Does the Mortgage Stress Test Examine?
Here are some of the criteria commonly examined when mortgage lenders undertake a mortgage stress test:
Debt-to-Income Ratio (DTI)
This is a crucial factor that measures your total monthly debt payments against your monthly gross income. A lower DTI ratio is more favourable as it suggests you have more income available to manage a new mortgage payment. The ideal DTI ratio varies among lenders but is often around 43%.
Credit Score
Your credit score is used to determine your creditworthiness. A higher score indicates that you are less of a risk to lenders. Different mortgage products have different credit score and credit history requirements, but generally, a higher score can secure you a more favourable interest rate.
Loan-to-Value Ratio (LTV)
This ratio is calculated by dividing the loan amount by the property’s appraised value. A lower LTV is usually more favourable to lenders because it means you have more equity in the property, reducing their risk.
Employment History and Income Stability
Lenders prefer applicants who have stable employment and a steady income. You’ll usually need to provide proof of income through tax returns, W-2 forms, or recent pay stubs. Self-employed individuals may have to provide additional documentation.
Assets and Liabilities
Some lenders might look into your assets (savings, investments, other real estate or valuable possessions) and liabilities (other loans, consumer debts) as additional indicators of your financial stability and ability to repay the loan.
Interest Rate
The interest rate environment can also influence stress testing. In a rising rate environment, lenders may use a higher rate to calculate your ability to meet future payments.
Property Appraisal
The lender will often require a professional appraisal of the property to ensure it is worth the amount of the mortgage. This is crucial in determining the Loan-to-Value ratio.
Down Payment
The size of your down payment, or deposit, can also be a factor. A larger down payment reduces the loan amount and the lender’s exposure to risk.
These are ways in which you can ensure your suitability for a mortgage and pass thet various aspects of the test to secure a mortgage.
1. Be Prepared for the Mortgage Stress Test
Mortgage stress tests are used to ensure borrowers can afford their payments should interest rates increase. They apply equally to new borrowers as well as those renewing existing mortgages.
The test applies at a rate higher than what the borrower’s contract mortgage rate specifies; typically calculated as either 5.25% of their actual mortgage rate +2%.
For you to pass the mortgage stress test, you must ensure you have enough income to cover both monthly housing expenses and debt payments – this can be measured using Gross Debt Service (GDS) and Total Debt Service (TDS) ratios which measure as a percentage of your total income.
OSFI introduced the Stress Test as a measure to protect potential homebuyers from taking on loans that were too large for them, to protect potential buyers against taking on an unaffordable mortgage. All potential homebuyers applying for conventional uninsured and insured mortgages subject to CMHC premiums must take part.
2. Make Your Payments on Time
Since last year, prospective homeowners must pass a mortgage stress test in order to qualify for their dream home. The stress test simulates higher interest rates than your contract rate in order to ensure you can still afford your payments should rates increase in future.
To successfully pass a stress test, you must demonstrate that your income covers your mortgage payment and that your debt-to-income ratio is low. To prepare, try paying off any outstanding debt you can and practicing budgeting.
Anyone applying for a mortgage from federally regulated lenders regulated by OSFI – banks and credit unions – must undergo the stress test. In contrast, provincially regulated lenders like most credit unions and some private lenders do not require stress tests, since their assessments provide more comprehensive analysis of your finances.
3. Get a Better Deal
Since 2018, Canadians looking to purchase or refinance with mortgage financing must pass a stress test. Banks use this calculation to model loan affordability if interest rates rise unexpectedly; and to prevent mortgage defaults.
Stress tests are performed by multiplying your desired mortgage amount with either the Bank of Canada’s benchmark rate of 5.25%, or your current mortgage rate plus two percentage points. This figure serves as your “stress test rate”, and any mortgage that exceeds this figure would not be affordable to you.
However, there are other avenues available to borrowers who do not pass the stress test that do not require them to go through this rigorous process; these alternatives include credit unions, private lenders and mortgage finance companies.
4. Look for Private Funding Options
Since 2018, homebuyers applying for or renewing with a federally regulated lender must pass the OSFI Mortgage Stress Test to qualify. This stress test assesses an individual’s ability to afford monthly payments at an interest rate higher than their contract mortgage rate plus two percent.
The new assessment rate has significantly diminished the purchasing power of prospective Canadian homeowners, forcing them to either save longer or reduce their ideal home selections. It has also created obstacles for current homeowners seeking refinancing or switching lenders.
There are workarounds for those frustrated by the mortgage stress test, however. You could seek lenders outside of federal regulations like credit unions and private lenders in order to bypass it entirely. Furthermore, by paying off existing debt you can decrease your total debt ratio and boost income thus making qualifying easier – don’t give up your dreams of homeownership just yet!