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Adapting to the mortgage stress test

July 6, 2021

Written by Penelope Graham

Key takeaways

  • Borrowers must prove they could afford to make their mortgage payments at a rate of 5.25%, or their contract rate plus 2%, whichever is higher.

  • Being tested at a higher rate means borrowers can expect to qualify for a smaller mortgage amount.

  • The stress test is designed to be most impactful in Canada's most expensive cities.

Adapting to the mortgage stress test

The most recent update to the federal mortgage stress test implemented by Canada's banking regulator and Department of Finance is in place.

What is the mortgage stress test?

The stress test was first announced in October 2017 by the Office of the Superintendent of Financial Institutions (OSFI) and came into effect on January 1, 2018. This latest update came into effect on June 1, 2021. This stress test applies to federally regulated financial institutions.

The stress test requires borrowers to qualify for home financing at a higher rate than their actual mortgage interest rate. The most recent iteration requires borrowers to prove they could afford to make their mortgage payments at a rate of 5.25%, or their contract rate plus 2%, whichever is higher. This is an increase from the previous stress test floor, which was 4.79%.

Unlike previous versions of the stress test, which varied depending on whether mortgage applicants were making a down payment above or below a 20% on their home purchase, this criteria applies to both insured and uninsured mortgage borrowers. The stress test could change in the future.

Why have a mortgage stress test?

Requiring that borrowers qualify at a higher stress test rate is a tool that OSFI and the Department of Finance have to ensure borrowers will be prepared when interest rates rise. The current cost of borrowing is historically low due in large part to pandemic economic recovery efforts.

However, these very low interest rates have helped fuel unprecedented sales and price growth in the housing market. As a result, more Canadian borrowers have taken on risky levels of debt, which they may not be able to keep up with in a rising interest rate environment. In their most recent Financial Systems Review report, the Bank of Canada (BoC) identified overly leveraged households as a key vulnerability facing Canada's economy, with more borrowers taking on a higher loan-to-income ratio.

Usually, the BoC could respond by increasing interest rates to cool risky borrowing levels but the nation is still grappling with pandemic-induced economic fallout. Therefore, a tougher stress test for borrowers is a tool currently available to reel borrowing back in.

How will the latest stress test update impact home buyers?

Simply put, being stress tested at a higher rate means borrowers can expect to qualify for a smaller mortgage amount, all other things being equal. But how does this translate into dollars?

According to analysis by tech real estate brokerage Zoocasa, borrowers can expect to receive between $14,000 and $47,000 less for their mortgage qualification, depending on their local market.

The study calculated the income required to qualify for a mortgage large enough to purchase the average-priced home in 11 cities across Canada at both a mortgage rate of 4.79%, and then at 5.25%. It was assumed home buyers had no additional debt, were making a 20% down payment, and were amortizing their mortgage over 30 years. The study also determined how much more income the borrower would need to qualify for the same sized mortgage at the updated stress test level.

The stress test is designed to be most impactful in Canada's most expensive cities. Borrowers trying to purchase the average-priced home of $1,211,223 in Greater Vancouver would see the largest reduction in their mortgage qualification amount, at $47,170.

Next was Greater Toronto, where qualification would be reduced by $42,475 on the average home price of $1,090,992, resulting in a requirement of $8,000 in additional income.

In contrast, the buyers least impacted by the stress test were found in Saskatoon and Winnipeg, where average home prices are $347,616 and $353,377, respectively. Qualification amounts in each would be reduced by $13,661 and $13,875, requiring an income increase of $2,000 to qualify for the same size mortgage.

The national breakdown can be seen in the infographic here.

How to prepare for the mortgage stress test

Reduce your expectations: the reality of the stress test is that buyers can't afford as much as they previously could. Lenders will be offering smaller mortgage financing amounts to applicants as a result of the higher qualification rates, and that will trickle down into the type of inventory buyers can afford. This could mean buying a condo or townhouse rather than a detached home, or looking to more affordable regions.

Don't buy at the top of your budget: while your lender may pre-approve you for a specific amount, it's not always prudent to use every last penny of what you qualify for – and the stress test is designed to impact overextended borrowers the most. Staying well below this affordability ceiling can help avoid stress test-induced surprises at the mortgage financing stage.

Don't overbid: it can be easy to be caught up in multiple-offer situations, especially in Canada's highly competitive markets. If a home's value is overblown compared to the lender's appraisal, you may be offered less mortgage than you need to complete the purchase.

All Tangerine Bank mortgage applications are subject to Tangerine Bank's, and if applicable, the mortgage default insurer's, standard credit criteria, residential mortgage standards and maximum permitted loan amounts.

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