A stress test asks you to envision a worst case scenario. When it comes to your mortgage, this means considering what you could afford if your circumstances changed in the most drastic way. Let’s say you lost your job or incur unexpected expenses, can you still pay your mortgage?
What is the Mortgage Stress Test?
The Mortgage Stress Test is done by banks for homeowners seeking a high-ratio mortgage to see if you could afford your payments at a higher interest rate.
In Canada, the mortgage stress test is a legal requirement. You must pass the test to show you can afford your mortgage at a qualifying interest rate, which is usually higher than the rate in your mortgage contract. It was created to protect borrowers and ensure that if/when interest rates rise you’ll still be able to afford your mortgage payments. Credit unions and other lenders that are not federally regulated do not require the mortgage stress test.⠀
How the mortgage stress test works
When you apply for a mortgage, the bank offers you an interest rate based on your credit score, income, and expenses. This rate will be contracted, meaning it is a quoted annual rate. The contracted rate, however, is not what lenders use to determine your mortgage eligibility. Instead, they will make calculations based on higher interest rates.
What interest rate does the lender use to determine your mortgage eligibility?
The minimum qualifying interest rate for both insured and uninsured mortgages will be the higher of the following rates:
- The Bank Of Canada qualifying rate
- Your contracted rate plus 2%
You can use this Mortgage Qualifier Tool to determine if you qualify for a home mortgage by filling out property information and your income and anticipated expenses.
How the bank determines what you can afford
In order for the bank to determine what you can afford, you need to have a high enough income and low enough debts to be able to pay off your mortgage at a higher rate than your contracted rate. The two main factors that lenders look at to determine your eligibility are gross debt service ratio (GDS) and total debt service ratio (TDS).
The GDS is a measure of the borrower’s monthly housing expenses. The TDS is a measurement that determines the amount of gross income that is already spent on incurred debts and expenses. This measurement is based on things like credit card balances, property taxes, and any other debts to calculate the ratio of the borrower’s income to debt.
How to “pass” the mortgage stress test
The mortgage stress test isn’t something you technically “pass”. Rather you are determining eligibility. And all you can do is prepare your finances as best as you can before becoming a home owner. This means paying down debts, saving up what you can, and if necessary consider looking into having a co-signer. Doing these things will help you get the mortgage you require that works for you!
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