The mortgage stress test rate has fallen once again. This is the third time since Covid-19 started. In this article, we’ll look at what the mortgage stress test is, why does it matter and what the lower stress test rates mean for you if you’re thinking of buying a home or your mortgage is coming up for renewal.
What is the Mortgage Stress Test and Why Does it Matter?
Banks and mortgage brokers use the stress test to determine if you qualify for a mortgage. Under the stress test, they use a made-up mortgage payment for qualifying you. You must be able to prove that you can afford mortgage payments at your mortgage rate (referred to as the contract rate) plus two percent or the mortgage stress test rate (also referred to as the benchmark qualifying rate), whichever is greater.
Regulators want you to be able to prove that you can afford higher mortgage rates if and when they arrive. They want you to help avoid “payment shock” if mortgage rates are a lot higher when your mortgage comes up for renewal.
The Mortgage Stress Test Falls for the Third Time Since the Start of Covid-19
For the third time since the pandemic started, the mortgage stress test rate has fallen. The posted 5-year fixed rate of the big banks has been inching lower in recent months due to Covid-19 negatively affecting the Canadian economy. The posted 5-year fixed have fallen enough that the Bank of Canada has dropped the stress test rate from 4.94 percent to 4.79 percent.
This is a big deal because the posted rates of the big banks are a metric used by the Bank of Canada to determine the mortgage payments qualified borrowers can comfortably afford. The stress test was originally brought in 2016 for those with insured mortgages. It was soon expanded to those with uninsured mortgages.
The idea of the stress test was to cool off an overheated real estate market. Some would argue that it’s done the job. Home prices haven’t been growing at the same level pre-stress test in many areas. Although, there may be other factors at play driving the demand of the housing market.
Passing the Mortgage Stress Test
Even if you can afford the monthly payments at current mortgage rates, you have to pass the stress test in order to get a mortgage. The stress test has acted as a barrier to entry to those who want to enter the housing market and can afford the monthly payments, but can’t pass the stress test.
As mentioned earlier, previous to this the stress test rate has already fallen twice since the beginning of the Covid-19 pandemic. The stress test rate first fell in the middle of March by 0.15 percent from 5.19 percent to 5.04 percent. Then it fell again a couple of months later in May by 0.10 percent from 5.04 percent to 4.94 percent.
The latest rate reduction means that if you’re a qualified borrower, you can afford to spend more on a home than you were able to prior to the change all things considered equal. Even if your income, debt and down payment are the same, you can qualify for more mortgage money.
The latest change gives borrowers about an increase of 1.5 percent in their home buying purchasing power. If you have a household income of $100,000 and were putting 10 percent down on a property, you could afford to spend roughly $523k on a home at a stress test rate of 4.94 percent. However, at a lower stress test rate of 4.79 percent, you can afford to spend slightly more, about $531k on a home. That’s an increase in purchasing power of about $8k. Not a huge difference, but not a drop in the bucket either.
Mortgage Stress Test Updates:
According to BMO, as of June 1, 2021, the minimum qualifying rate is based on:
- either the benchmark of 5.25%
- or the rate offered by your lender plus 2% – whichever is higher.
For example, even if your lender offers you a rate of 2.99%, you have to use the 5.25% qualifying rate in your stress test. However, if your lender offers a rate of 3.49%, you’ll have to qualify using a rate of 5.49%.
Qualifying for Mortgages
Over the past several years, the government and regulators have made it tougher for Canadians to qualify for mortgages. It’s nice to see homebuyers catch a break for once.
The Office of Superintendent of Financial Institutions (OSFI) had made plans to change how the stress test was calculated back in February. However, those plans like many others were put on hold due to Covid-19. Crown corporation the Canada Mortgage and Housing Corporation has since introduced stricter rules for insured mortgages. However, the two other mortgage insurers didn’t follow suit, leaving mortgage rules the way they were.
It’s interesting to note that the stress test rate went up a lot faster than it has gone down. The big banks like National Bank wasted no time in hiking their posted rates when rates were trending up. Now, the banks seem to be taking their sweet time cutting the posted rate. This is largely due to mortgage penalties.
The big banks calculate their fixed-rate mortgage penalties based on their posted rates. If posted rates were to fall, the banks would make fewer profits from mortgage penalties. They’re already hurting from Covid.
The reduction in stress test rate comes at a time when Canadian mortgage rates are at record lows. We haven’t seen mortgage rates this low since the financial crisis in 2008. If you’re a well-qualified borrower with a stable job situation, there’s never been a better time to buy.
Are you considering buying a home? Reach out to our offices today. We can help to see if homeownership makes sense for you.