If you’ve been considering buying or refinancing any time soon, you may have come across the term “Stress Test” and wondered what is a stress test and why does it matter to you.
We aren’t talking about a medical stress test, although many of us may need one if the home prices keeps rising at the rate they have been, we are talking about a mortgage stress test which can affect your ability to purchase the home you’ve fallen in love with. With Toronto real estate prices as high as they are and at the speed in which they are rising at the time of this blog post (February 2022), it is important to understand what a stress test is and how it applies to you when making a move. Below is a detailed explanation as to what a stress test is and how it can affect your purchasing power.
What Is Stress Test:
Because mortgage rates can fluctuate, as of 2016, the Canadian government introduced a minimum qualifying rate in order to reduce the risks associated with mortgage lending. This qualifying rate ensures that you are still able to cover your mortgage payments even if rates rise above your original qualifying rate as the qualifying rate is higher than your contract rate with your lender. This rate is based on a number of factors including your current credit score, credit history, total amount being mortgaged, current debts and your income.
How A Stress Test Works:
When you apply for a mortgage with a lender, your lender will provide you with a contract rate which is based on current interest rates, your credit history, the structure of your mortgage and current economic factors at the time of your application. Although your lender will provide you with a contract rate, they are required to qualify you first at a higher qualifying rate in order to ensure that you could cover your mortgage payments even if rates rise. This process is simply a risk assessment for your lender.
Why The Stress Test Was Introduced:
The test was introduced in 2016 when the Toronto real estate market was thriving and when homeowners were taking on substantial household debt. The test was originally only required for insured mortgages (a mortgage that includes mortgage default insurance) and with less than a 20% downpayment. The main goal of introducing this test was to provide both the lenders and homeowners with a buffer should anything happen that would increase the interest rate or monthly payments. The Canadian Government later extended this test requirement to uninsured mortgages as well (mortgages without default insurance and with more than 20% down). Not only does this test affect those who are applying for their first mortgage but also those who are looking to refinance.
How Does The Stress Test Affect Borrowers:
Due to the fact that borrows need to be approved on a higher rate than the contract rate, some buyers (depending on their financial situation) will have reduced buying power and may have to settle for a home at a lower price point. This can make the buying process somewhat frustrating if you aren’t able to find a property that fits your needs.
One positive aspect of the test is that you as the buyer know you won’t be over extending yourself financially.
Can You Avoid A Stress Test:
Unfortunately, you cannot avoid a stress test as all major banks and lenders are required by law to complete stress tests on their borrowers.
How To Calculate What You Can Afford Based On The Stress Test:
The Government of Canada has created a mortgage stress test calculator which allows you to calculate what you can afford based on the test. You can access the calculator HERE to determine how much you can be approved for based on your specific information and circumstances.
It’s very important that you always speak with your lender and get pre-approved before submitting an offer on a property in order to avoid running into any financial hiccups.
Are you thinking about making a move and have questions? Contact me any time, I’m always happy to help.