Taking out a mortgage is usually the largest financial commitment many Canadians make – and in today’s environment of unstable interest rates, signing on the dotted line for a mortgage can come with significant risks.
However, this risk has been largely mitigated by the mortgage stress test in Canada. This borrowing threashold is a way to prepare for the worst when it comes to rising rates and eroding affordability such as we have experienced in the recent past. And it is a legal requirement in Canada.
Here’s what you need to know if you are in the market for a new mortgage.
In finance, planning for a worst case scenario is called a stress test. It involves modelling a negative scenario before an investment is made.
The mortgage stress test is a way of determining exactly how much you can afford (and under what circumstances) if your income is reduced by any outside influences. If this situation develops it is important to know if you could still afford to make your mortgage payments.
When you apply for a mortgage, you will be offered a contract rate. This happens after your financial institution has satisfied themselves you are able to pay back the loan after they have completed all their research into your current income and debt level ratios. They will then check on the minimum qualifying rate as set by the Superintendent of Financial Institutions. This qualifying rate is based on the mode average of posted 5 year fixed rates from Canadian banks. So your mortgage interest rate would be this rate plus 2%. This means your income needs to be high enough, and your existing debt low enough, to be able to pay down your mortgage at that higher rate. Generally, this will result in you only being able to borrow a smaller amount, and most likely buying a less expensive property.
What happens if you fail the stress test?
If your income is too low to carry the mortgage payments at the higher stress test rate, or you are unable to prove you have a consistent income stream, you can fail the mortgage stress test, and your lender will refuse to provide you with the funds you are looking for. In the event this happens, you and your borrowers have some different options :-
Reduce the value of the home purchase.
Look at B Mortgage Lenders.
Look for a co-signer for your mortgage.