What You Need to Know About the Mortgage Stress Test

Wednesday Sep 30th, 2020

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What You Need to Know About the Mortgage Stress Test

Picture this.

It's the night before you officially make your mortgage application and you're tearing through your to-do list like the head coach of a team getting ready for the Super Bowl.

Down payment? Check.

Credit Score? Check.

Proof of income? Check.

Enough income for the mortgage stress test?

You pause, pen hovering over your paper as you stare at your checklist in disbelief. 

What in the world is that? You gulp.

In basic terms, the mortgage stress test is like the final exam of your mortgage application. Pass and you're likely approved. Fail and you won't qualify.

It's kind of a big deal. 

But just like an academic paper or a final exam, you can still ace the mortgage stress test with a little know-how and preparation. And we're about to tell you how.

What is the Mortgage Stress Test?

We all know that one person who always has an oddly specific answer to the question, "What's the worst that could happen?"

Maybe you're that person in your circle.

In social settings, you might hear words like "always prepared" or "worry wart" thrown around to describe this. But in finance, imagining worst-case scenarios and making sure you have a plan is the basic premise of what's known as a "stress test".

So getting back to buying a house, the mortgage stress test is a way of making sure you can afford to pay even if interest rates change or you end up being forced to take a pay cut. 

Originally, Canadians applying for uninsured or high-ratio mortgages had to pass this test in order to be approved.

How Does it Work? 

It starts out like any standard loan application with the bank offering you a mortgage rate based on the usual factors like income, current debt, mortgage amounts, and so on. 

The exact rate you get offered will ultimately depend on details like your credit score and your mortgage provider, but there are still ways to set yourself up for success in the early stages. With a quick search online, these days you can find companies that allow you to compare mortgage rates for free, so doing your own due diligence has never been easier. 

However, assuming everything checks out during this first assessment, your lender still has to see how much you can afford under the mortgage stress test. 

Here's how they do it:

Lenders have two percentages they can calculate against.

These would be:

  1. The Bank of Canada's 5-Year benchmark rate

  2. Your offered rate plus 2%

They'll choose the highest number and if you qualify, you're approved for that amount.

Unfortunately, a lot of applications get stuck here because most aspiring homeowners will qualify for less money than they would have before these rules were introduced.

But even so, landing your dream home is still possible with the stress test. You may just have to plan a little more in order to get there.

How To Pass the Mortgage Stress Test With Flying Colors

1. Make a Larger Down Payment

Now that the stress test applies whether you're paying 5% or 20% down, you might be asking yourself, "Is there a point to saving more?"

In this case, there is.

When you have more money saved that you can put towards your house, you can afford to ask for a smaller mortgage. And the smaller your mortgage is, the better your odds of approval become.

2. Pay Down Your Debts

If there's one metric that lenders care about, it's your total debt service ratio. This is the number that financial professionals use to get a sense of how much of your money is going to bills and other outstanding expenses each month.

To calculate this, monthly debts like your credit card payments, personal loans, and car payments are added up and then divided by your gross monthly income. 

The lower this number is, the easier it will be for you to qualify even with the mortgage stress test. Lenders will see that you have a little bit more disposable income on account of the fact that you just don't have to spend as much money paying down debt each month.

3. Consider Buying at a Lower Price Point

Going into the home-buying process we all have certain non-negotiables. Some people want a spacious backyard. Other people need a kitchen island. And the list goes on.

But even if you've been eyeing $600,000 properties so far, you may be able to find comparable homes in the $500,000 or even $400,000 range.

This is another hack you can use to make the mortgage stress test more or less a formality.

Conclusion

For most homeowning hopefuls, the words "stress" and "test" beside the word "mortgage" don't exactly inspire warm and fuzzy feelings. But here's the thing: even though you have to pass the mortgage stress test, that doesn't mean you can't be approved. If you try out any of these tips, you might be surprised at just how smoothly the mortgage application process goes for you. 

 

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