It’s been a tough time for homeowners. In a short period of time, we saw the prime rate increase a whopping 7 times. In fact, interest rates increased at their fastest pace in 30 years. Mortgage rates have, of course, followed suit.
Anyone with a variable-rate mortgage is experiencing the impact of higher interest rates. Some people with a variable rate mortgage saw their payment increase by more than $1,000 per month. Likewise, if you have a fixed-rate mortgage you are feeling the impact of higher rates, with your payment jumping up at renewal as well.
Higher interest rates coupled with the mortgage stress test are locking people out of accessing their home equity. We’ll discuss that, the mortgage stress test and more in further detail.
What is the mortgage stress test?
The Canadian government put the mortgage stress in place several years back. The whole idea was to avoid Canada experiencing a housing crash similar to what the U.S. experienced in 2008.
The mortgage stress test requires proof that you can handle mortgage payments that meet the greater of two guidelines. The first is the current benchmark rate, which is 5.25% right now. The second is the lender’s mortgage rate plus 2%.
For example, if your mortgage rate is 4.99%, then you’d need to qualify at 6.99% (4.99% plus 2%) since 6.99% is greater than 5.25%.
These tests prove that you have enough household income to handle mortgage rates going higher. By passing, it shows you should be able to handle higher mortgage rates at renewal if you choose a fixed rate. Or if you chose a variable rate, you should be able to handle higher payments if the prime rate goes up during your mortgage term.
When do you need to pass the stress test?
There are many circumstances where you must pass the mortgage stress test, including:
- Taking out a mortgage with a prime lender
- When buying a home
- Transferring to another lender
- Refinancing your mortgage
It’s important to note that passing the stress test is required regardless of your down payment size. Whether you are putting down more or less than 20%.
The only time you might not need to pass the stress test is when taking out a mortgage with a credit union or alternative lender (more on that below).
People are being locked out of accessing their home equity
Higher interest rates and the mortgage stress test are leaving people locked out of accessing their home equity.
Mortgage financing is generally the cheapest form of financing available. That makes it ideal when you need to borrow money for home renovations, to consolidate debt or for investment purposes.
Yet, higher interest rates and the mortgage stress test have made it more difficult to access that equity through refinancing.
It’s a high hurdle to overcome when you need to pass a stress test of, in some cases, almost 8%. Some Canadians simply don’t qualify. This is pushing people into highest-cost financing. For example, unsecured loans or lines of credit, or mortgage financing with alternative or private lenders.
Is this really in the best interest of the borrowers? It’s hard to see how it is.
There has also been criticism of needing to pass the stress test when switching lenders at renewal.
Passing the stress test when you’re buying a home and taking out a new mortgage makes sense. However, does it make sense to need to pass the stress test when switching lenders?
If you are keeping your mortgage balance the same, forcing someone to pass the stress test when switching lenders simply doesn’t make sense. It’s potentially locking someone out of being able to investigate better mortgage options at renewal. All, simply, because they can’t pass the mortgage stress test.
Should the government revise the stress test?
The stress test has received criticism over the years for locking people out of the housing market.
The stress test rate currently sits at 5.25%, but Canadians haven’t had to qualify at that rate for quite some time. Canadians have been qualifying for the mortgage rate plus 2% for months now.
Currently, fixed mortgage rates are in the 4-5% range and variable in the 5%-6% range. The stress test, therefore, requires Canadians to qualify at a rate that’s 2% higher: 6-7% for a fixed rate and 7-8% for a variable rate. With nobody predicting that mortgage rates will reach that high, does qualifying at your mortgage rate plus 2% need to be revised?
Based on the current stress test, you need to have a household income of a whopping $200k just to afford an average home in Toronto. Most people don’t earn that much. That means unless you have wealthy parents to help you, you could be locked out of buying a home in the big city, all because of the stress test.
Don’t get me wrong. The stress test is a prudent financial measure. We certainly don’t want a housing crash like the U.S. That being said, we’re in unprecedented times, so the mortgage stress test should be reviewed. It’s time to see what changes could be made to make it more reflective of the current reality.
Also, does it make sense to have borrowers required to pass the stress test when taking out a 5-year mortgage term? 5 years is a long time. Perhaps it would only make sense for borrowers to pass the stress test when taking out a shorter-term mortgage, such as a 1 to 3-year term. That’s some food for thought.
Or maybe the stress test doesn’t apply when you take out a 7 or 10-year mortgage term. However, those mortgage terms come with hefty mortgage penalties, so I’m not the biggest fan of them.
Ways to get around the mortgage stress test
If you have at least 20% down on a property, there are lenders out there where you don’t need to pass the mortgage stress test. You can qualify solely based on your mortgage rate, like in the old days.
Provincially regulated credit unions aren’t required to use the mortgage stress test. Some are choosing to, while others aren’t. If you have at least 20% down and you’re looking to stretch your home budget, you might consider applying for a mortgage at a credit union.
Before you do that, it’s important to stress test your own finances. The mortgage stress test takes other debt you might have like a car loan or student debt into consideration, but it doesn’t look at general household expenses. For example, it doesn’t look at spending on childcare, groceries, and elderly parents.
As such, you want to factor in those household expenses yourself. Do your own analysis to make sure that you’re not spreading yourself too thin financially by forgoing the stress test.
Alternative lenders also aren’t required to use the mortgage stress test. Be wary, with those lenders, expect to pay 1-2% higher than standard mortgage rates, and lender fees of at least 1% of the mortgage amount.
It would be prudent to do your research. Review the options available at the credit union and alternative lenders. Then decide which one makes the most sense based on their offerings.
The mortgage stress test isn’t changing anytime soon, so if you need to access equity from your home, you’ll want to make alternative plans.
If the stress test is preventing you from accessing equity from the banks speak with your trusted mortgage professional. You may be able to access it from a credit union or alternative lender.
That way you can still get the financing that you need and put yourself in a better position financially for the future.
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