On October 17, 2017, the Office of the Superintendent of Financial Institutions announced new mortgage rules, which were officially put into effect on January 1, 2018. The new regulation requires lenders to conduct a mortgage stress test, a stringent assessment of borrowers’ ability to service mortgage payments in the event of interest rate increases.
This new set of rules governing mortgage lending was established to protect borrowers. Average household debt in Canada has been steadily rising over the years (studies show the average household is indebted at 170% of their disposable income). The government wants to ensure that consumers who obtain a mortgage loan are able to afford it. Otherwise, they risk going into default. And of course, if mortgage defaults become widespread due to relaxed lending standards, it could result in an economic disaster for the country as a whole.
The stress test regulations only apply to federally regulated lenders; credit unions and other lenders that are regulated at the provincial level are exempt (though they may use them voluntarily).
The addition of the stress test means that in order to qualify for a mortgage, you’ll have to prove to your lender that you can afford payments at a rate which is higher than the actual rate in your mortgage contract. This rate is called the “qualifying rate.” The stress test rules don’t apply if you’re renewing your mortgage with your existing lender.
The stress test applies to everyone. If you have perfect credit and 20%+ down payment, you’ll still have to go through it to secure a mortgage.
So how is the stress test rate determined? The lender will use the HIGHER interest rate of the following as your mortgage qualifying rate (stress test rate):
- The Bank of Canada’s standard five-year mortgage rate
- The interest rate you agree to with your lender plus 2%
Your lender determines what size of mortgage you can afford based on the GDS (gross debt service ratio) and TDS (total debt service ratio), which calculate your debt load and how much of your income goes towards servicing it. Because the higher interest rate from the stress test is used to arrive at the figures, the ratios will be higher than they otherwise would have been, potentially disqualifying you from the amount you were seeking to obtain.
If you’re looking to renew or refinance your mortgage with a new lender, it’s critical to assess where you stand financially using the GDS and TDS ratios. You want to know what you can expect in terms of financing so that you don’t get caught by surprise if you’re not approved for the amount you were originally hoping for.
So what does the stress test mean for you as a first-time home buyer? It means that it could be more difficult for you to qualify for your ideal mortgage. You’ll have to be open to different options, such as settling for a smaller mortgage, increasing your down payment, getting a co-signer or trimming down your existing debt. In any case, it’s time to sit back and crunch some numbers.