Are you considering buying a home in Canada? Congratulations! Becoming a homeowner is an exciting milestone, but it can also be overwhelming. There are many things to consider when purchasing a property, including the infamous stress test that was introduced in 2016.
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What is the Stress Test?
The stress test, also known as the mortgage stress test, is a financial assessment that potential homeowners in Canada are required to pass before they can obtain a mortgage. It was introduced by the Office of the Superintendent of Financial Institutions (OSFI) in an effort to ensure that Canadians are not taking on more debt than they can afford.
How Does it Work?
The stress test requires potential homeowners to prove that they can make mortgage payments at a higher interest rate than the one they have applied for. This higher rate is typically based on the Bank of Canada’s five-year benchmark rate or 2% above the rate offered by the lender, whichever is higher. The purpose of this test is to ensure that homeowners can handle their mortgage payments even if interest rates rise in the future.
Who Does it Apply to?
The stress test applies to all potential homebuyers who are seeking a high-ratio mortgage. This includes first-time homebuyers, but also those who are looking to refinance their existing mortgage or switch lenders.
Who is Exempt?
Existing homeowners who are renewing their mortgage with their current lender are generally not subject to a stress test. Unfortunately, this tends to be the only exception. Existing homeowners who are switching to a new lender, refinancing or taking out a line of credit are all usually subject to a stress test.
What Happens if I Fail?
If your income is too low, or you are unable to provide proof you have an ample source of income, you may fail the rest and your lender may refuse to provide you with the required funds to purchase a home at the stress-tested price. Borrowers have a couple of options if this happens. Finding a home with a lower purchase price is the most obvious, as this will mean a lighter borrowing requirement. You could also look into alternate mortgage lenders who are capable of modifying certain elements of your mortgage, but this will generally come with higher interest rates than A-tier lenders. There is also the option of finding a co-signer who will assume the credit risk and responsibility of paying off the mortgage in the eyes of the lender.
Tips for Passing the Stress Test
If you are planning on buying a home and will be subject to the stress test, here are a few tips to help you pass with flying colours:
- Save for a larger down payment: The more you can put down, the more likely you are to pass the stress test. Plus, having a larger down payment can also mean lower monthly mortgage payments.
- Reduce your other debts: Lenders will look at your debt-to-income ratio when determining if you can afford a mortgage. Paying off or reducing your other debts can improve your chances of passing the stress test.
- Consider a co-signer: If you have a family member or friend who is willing to co-sign your mortgage, it can increase your chances of being approved as their income and credit score will also be taken into consideration.
The stress test may seem daunting, but it was implemented with good intentions to protect Canadian homeowners from taking on more debt than they can handle. By knowing the ins and outs of the stress test, you can better prepare for the home-buying process and increase your chances of passing.