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The basics of the Canada mortgage stress test

What is the Canada mortgage stress test?

Many Canadians will need a mortgage for their home buying ventures and meeting the bank’s requirements to get one is an essential part of the process. The Canada mortgage stress test was originally only for homebuyers who had a large income to housing price ratio, which is the house price divided by the homebuyer’s income. A lower ratio indicates that the house is more affordable to that specific buyer. They became universal to every Canadian to reduce homeowner debt.

It may seem like the stress test is only there to give potential homeowners a challenge, but it’s there to protect the interests of both the mortgagee and the mortgagor. Even though the mortgage affordability test is a good measure to prevent people from defaulting on their mortgage, the test is still a considerably difficult hurdle to overcome. Fortunately, there are ways around it.

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The basics of the mortgage stress test in Canada

Since the stress test was first implemented in 2018, you may be surprised about this new addition in the application process. Before then, the test only applied to uninsured mortgages; after that, the stress test was also observed for insured mortgages. The result of the test is very important to mortgage brokers and banks and can impact the chances of getting approval. For some home buyers, it gives an additional advantage.

When considering the test, your finances and affordability will be challenged against an artificial interest rate. It’s usually 5.25%, but your finances can also be challenged against the current posted rate with an added 2%. The higher rate will be chosen in the test. This rate is also called the qualifying rate. Even though that may not be the mortgage rate that you end up with, lenders want to be sure that you can handle any possible changes in the future.

Mortgage stress test rules

While it seems that every single home buyer who needs a mortgage to complete their purchase should undergo the test, it is only applicable in certain situations.

  • Federally regulated lenders – traditional financial institutions are federally regulated lenders unlike alternative lenders and credit unions. If you wish to get your mortgage from a bank, you’re more likely to face the mortgage stress test.
  • Mortgage renewal – if you’re simply renewing your mortgage, the stress test won’t be applicable to you. Only the first and following mortgages will require you to undergo the test.
  • Conventional mortgages with a down payment of over 20% – as of 2023, those applying for a conventional mortgage with a down payment greater than 20% will have to face the stress test. Previously, only mortgages with down payments under 20% were exposed to the stress test.
An agent handing keys to a home buyer

Rules that change over the years

As the housing market and interest rate environment in Canada keep changing, the mortgage stress test has to accurately reflect these factors every year. In June of 2021, the stress test rate rose from 4.79% to 5.25%. Depending on the housing market, the stress test may rise again. It must always apply to mortgage affordability, affecting the price of the property they are able to purchase.

Additionally, a rule that got added at the start of 2023 was the Prohibition on the Purchase of Residential Property by Non-Canadians Act, which means that most traditional lenders will not provide mortgages to people who are not considered to be Canadian citizens or permanent residents. With the addition of this act, it’s possible that new acts could change the housing market in years to come.

How to pass the stress test

Some might find the name misleading and think that the stress test is something intellectual that you must study for, but the mortgage test is not like a university exam. The test is known by its alternative name, the mortgage affordability test, and applicants either pass or fail. Financial institutions will instead examine your income and credit score to see if you can afford the mortgage. They want to gain an understanding of your financial situation and make sure that they are not adding a lot of stress onto your current finances.  In essence the measure of affordability demonstrates if the borrower can afford the payments based on their usual cash flows and obligations and, for the lender it is an assessment of risk when providing a mortgage.

To increase your chances of passing the test, you can do any or a combination of the following:

  • Decrease your debt – the amount of debt a potential mortgagor has could change the outcome of the test. Lenders don’t want their borrowers to have more debt, so they’ll consider each person’s debt obligations, verifying if the borrower can take on the mortgage, home insurance, property tax, and so on. Having fewer financial responsibilities such as car loans or student loans shows the lender than you have more affordability towards the property.
  • Apply for a lower mortgage – it’s important to be realistic with your financial situation so sometimes getting a smaller loan can help with the approval. It’ll also make the monthly payments lower as well.
  • Confirm your income – the mortgage and interest rate are not the only monthly expenses when purchasing property. Banks and some private lenders may ask you to verify your income to make sure that your gross debt service ratio does not exceed 44%.

Despite the preparations that Canadians can take before applying for a mortgage, many also say that the stress test is just too difficult to pass.

Alternative ways to get a personal loan or a mortgage

As previously mentioned, the mortgage stress test is only applicable in distinct circumstances, which include applying for a mortgage at the bank. To bypass the mortgage stress test entirely, alternative lenders can provide you with the mortgage needed to complete your purchase without being subject to the stress test. Alternative lenders are more flexible and do not have the strict standards that the bank does.

Additional mortgages have even higher standards than a first mortgage because taking care of two mortgages at the same time can be heavy on a person’s finances and their affordability. To get around this, Canadians can look to alternative lenders like Alpine Credits for solutions. With Alpine Credits, homeowners can find approval without having to put stress on their finances. The only factor in your mortgage approval is the amount of equity in your home.

The equity in your home is the value of the difference between your outstanding mortgage and the property’s value. The loan can be used for debt consolidation, business endeavors, and of course towards a down payment on another piece of property. Homeowners who have paid for or accumulated at least 25% of the property’s value (home equity) can be eligible for a home equity loan. All they have to do is contact a Financial Solutions Specialist, complete the simple application process and find out the amount they could be approved for.

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