This weeks industry term which is used all the time, is the Stress Test. What is it and what does it mean for your mortgage?
The Stress Test was introduced in 2018 as a way to ensure that the Canadian Housing Market remains strong by making sure that home owners can afford their mortgage payments if mortgage lending rates were to raise. The way this was accomplished was to have lenders qualify a borrower based on the Bank Of Canada’s Qualifying Rate (or contract rate + 2%) rather than the actual contract rate that the payments were to be based on. The Contract Rate + 2% comes into effect if the actual mortgage rate received +2% would be higher than the BOC Qualifying Rate.
The Bank Of Canada Qualifying Rate is not a static number and changes when the BOC finds it necessary, based on the market and future trends; the most recent change was in June of 2021 when it was increased to 5.25% from 4.79%. This Stress Test was introduced towards Insured Mortgages (less than 20% down payment); however, OSFI has followed suit and most mortgages are Stress Tested using the BOC Qualifying Rate; including re-finances on your current property!
When qualifying a client using the Stress Test we need to ensure that the resulting GDS and TDS are kept in line and do not go over the maximum allowed.
Let’s see how it works in this example:
- 2 Clients on the file; shopping for their first home together
- Down payment available of $100,000 from their own savings
- Combined annual income of $140,000
- Other debts amount to $500/month
- Estimated Property Tax is $400/month and Heat is $120/month
Using the contract fixed mortgage rate of 2.99%:
The clients purchasing power would be roughly $950,000; or a mortgage of $850,000 after their down payment.
Using the qualifying mortgage rate of 5.25% (The Stress Test):
The clients purchasing power is drastically reduced to roughly $775,000; or a mortgage of $675,000 after their down payment.
The reason for the reduction in purchasing power in the example above is because the clients Gross Debt Service (GDS) and Total Debt Service (TDS) were calculated using the Stress Test Rate. Looking at the above example; even a small change in mortgage rates would mean that a house that cost $950,000 would be un-affordable to these clients with all other things staying the same and they risk falling behind on payments or defaulting on their mortgage.
It should be noted that at the time of writing; fixed mortgage rates are raising and variable rates are likely to raise as well. Should the fixed mortgage rates increase above 3.25%; the Bank Of Canada Qualifying Rate would no longer apply; since the mortgage would have to be qualified on the contract rate + 2% if is is higher. The easy thing to do in this instance would be to offer the clients a variable rate mortgage; however, if this product is not properly suited for the specific clients it may cause issues with approval!
The calculations performed in the above scenario were done using My Mortgage ToolBox App which can be downloaded here!
Check in next week for our next topic!
Published by Tyler Cowle!