Passing the mortgage stress test is required for all home buyers in Canada. But what are the stress test mortgage rules anyway? Is there a way you can avoid the stress test? And how is your minimum qualifying rate affected by recent rate hikes by the Bank of Canada?
In this article, we explain everything you need to know about the mortgage stress test. We also explore how it affects Canadian home buyers in 2022.
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What Canadians Need to Know About the Mortgage Stress Test
Want a new mortgage? Then you may have a lot of questions about the Canadian mortgage stress test.
In order to enter the housing market in Canada, the federal government mandates you first need to pass the mortgage stress test.
No, this is not the type of test you need to study for! But it’s still very helpful to know the stress test rules before jumping into a new mortgage application.
What is a Mortgage Stress Test?
Unless you are buying your next home in cash, you’ll need to qualify for a mortgage. Since mortgages are borrowed money, you’ll pay your mortgage lender additional interest.
The stress test checks if you can afford a slightly more expensive rate than what banks are currently offering. Doing this ensures you will still be able to afford your new mortgage payments even if interest rates go up during the amortization period.
That means, mortgage applicants need a high enough monthly income to afford what’s known as the minimum qualifying rate.
The mortgage qualifying rate is based on either:
- The benchmark rate set by the Bank of Canada
- Your mortgage lender’s rate, plus 2 percentage points
You’ll need to qualify for whichever option is lower.
So in short, what the mortgage stress test means is simple. When you figure out the maximum mortgage rate you can qualify for, you can’t use your bank’s lending rate alone.
As per the stress test rules, you need to figure it out with the slightly higher qualifying interest rate.
Why Do You Need to Take the Stress Test to Qualify for a Mortgage?
You need to take the stress test to prove you can afford your mortgage even if interest rates go up, or your income is slightly reduced.
Although that makes mortgage pre-approval more challenging for some Canadians, all federally regulated lenders require this test. That’s because this blocks people from signing onto a mortgage amount they might not be able to afford down the road.
Essentially, even if you could afford a large house with your current income, the future is still full of a lot of uncertainty.
The stress test puts an extra cushion around your income. It determines if you can still pay for your mortgage even if your life became less affordable. That may be because of a rising cost of living, or because of a downturn in the economy.
How Do You Pass the Stress Test?
Put away that pencil! Passing the stress test simple requires you to earn enough of an income to afford monthly mortgage payments with a slightly higher interest rate than what you’ll actually be paying.
That means to pass the test you need to either:
- Earn an annual income high enough to afford a mortgage with a higher interest rate
- Seek a mortgage with a lower purchase price so you could afford it with a higher interest rate
Do All Mortgages Require a Stress Test?
Short answer: Yes.
It doesn’t matter whether you are getting a variable-rate mortgage or a fixed-rate mortgage, you need to pass the mortgage stress test in order to qualify for a mortgage in Canada.
How Much Annual Income Do You Need to Pass the Stress Test?
This depends on the home you want to purchase. If you have a large income, you could qualify for a larger mortgage. If your income is small, you may need to buy something more modest.
Even though you might be able to afford a particular house on paper, the test is checking if you can still afford that house if the interest rate on the mortgage was slightly higher.
That means to pass the test, you need only buy a home that’s slightly more affordable than what you theoretically could afford currently.
Once again, this is to gage whether you could still afford the home even if your income was a bit lower or interest rates went up.
What’s the Minimum Down Payment Needed to Pass the Stress Test?
Although the stress test is not directly considering down payments, Canadian law dictates that you must provide a minimum down payment of at least 10% on your first home to qualify for a mortgage.
If this is not your first home, this can be as low as 5%.
With that said, even though financial institutions don’t directly consider your down payment for the test, it can still make an impact.
That’s because when you stress test mortgage payments, you check the mortgage affordability for only the interest payments on the remaining balance after your down payment.
Does Making a Large Down Payment Help You Pass the Stress Test?
Not necessarily. Just because you make a large down payment does not mean you’ll be able to afford a large house. It simply means the balance you’ll be tested for gets reduced by the amount of your down payment.
The larger your down payment is, the smaller the remaining housing costs, and thus, the more likely you’ll earn enough to afford the resulting qualifying rate.
Do Rising Interest Rates Affect Passing the Mortgage Stress Test?
They will. Every year the Department of Finance recalculates the qualifying rate to account for annual changes within the Bank of Canada’s outlook or the economy at large.
Since the BoC has raised interest rates, it is very likely the Department of Finance will follow suit.
Do You Need Insurance to Pass the Stress Test?
Just like with down payments, insurance is not considered by the stress test. With that said, it’s still smart to have.
While the stress test is measuring if you can still afford your house when interest rates go up, or your income is reduced, it’s still relatively modest considering how much amount interest rates have gone up in the last year, and how much a loss of income would affect monthly mortgage payments.
That’s why insurance is still important to get when buying a home. It can provide you with complete certainty you will still have your family home in a true worse case scenario.
How Can First Time Home Buyers Avoid the Mortgage Stress Test?
They can’t. If you are buying a home in Canada, you need to earn enough to afford the qualifying mortgage rate.
Does the Test Affect Renewals?
Yes, and no. If you stick with the same lender, then you don’t need to re-qualify for the mortgage stress test rate. You will however need to qualify for the stress test rate if you want to switch lenders.
Since the ability to switch lenders is a crucial part of getting cheaper mortgage rates, this is something you should strive for.
What Happens After You Stress Test Your Gross Income?
How Do You Know if You Passed?
You don’t need to wait for any results. If you know your income, if you know your down payment, and if you know the purchase price of the home you want to buy, than you can figure out whether or not you will pass.
The mortgage lender you go with likely has a mortgage calculator on their website you can play around with.
Simply put in your numbers, and for the interest rate, put in the qualifying rate. This will show you if you are able to afford the home on the spot.
What Can You Do if You Fail?
If you fail the test, then you need to either find a more affordable home, or find a way to earn a higher income. Admittedly, these are both much easier said than done.
If you are renewing your mortgage and have a lower income, you can still renew, you just won’t be able to check competing mortgage rates from a new lender without passing the test.
What Happens if You Lose Your Household Income After Qualifying for Your Mortgage?
Once you qualify for your mortgage loan, then you don’t need to retake the test. That means, mortgage borrowers that lose their income after signing are in the clear.
With that said, as per the agreed contract rate, you still need to make each monthly mortgage payment.
Let’s say interest rates go up or your income is reduced. If you no longer can make your monthly payments, what can you do? Basically: whatever is written in the contract between you and your mortgage lender.
To ensure you will always be able to afford the monthly payment (and other debt payments for that matter!), insured mortgages are much safer than uninsured mortgages.
- Learn more: 8 Benefits of Mortgage Life Insurance
Key Takeaways
- The mortgage stress test checks if you can still afford your mortgage even if it was a little more expensive
- It doesn’t matter which mortgage broker or financial institution you get your mortgage contract from, all Canadian mortgages require the stress test
- Instead of the rate set by Canada’s big banks, it uses the qualifying rate which is 2% higher
- First time home buyers and people looking to switch to a new lender (when they renew) must take the mortgage stress test
- Homeowners that want to stay with the same lender do not have to re-qualify
- Uncertainty in the future means uninsured mortgages are too risky
Keep Your Family Home in Your Family’s Hands
The mortgage stress test means you’ll have a slight buffer around what kind of home you can afford, but mortgage rules alone are not enough to protect Canadian home buyers and their families.
If you or your partner passes away, will your family still be able to afford the mortgage payments? It’s not fun to think about these things, but very important nonetheless.
The good news? It’s more affordable than ever to protect the family home.
Unlike the old type of mortgage insurance pushed by Canada’s big banks, you can finally protect the entire value of your home — not just the remaining balance your bank wants.
Click the blue button below to find out how much your could be saving on your life insurance today.
In less than a minute, you could save thousands each year while protecting your actual home’s value, and not the bank’s profits.
