The Stress Test

The mortgage stress test is an important aspect of the mortgage application process that aims to determine whether borrowers can still afford their mortgage payments in the event of a financial stress or interest rate increase. So, here's how it works. When you apply for a mortgage in Canada, the lender will assess your ability to repay the loan by considering a number of factors such as your income, employment history, credit score, and the size of your down payment. However, the stress test adds an extra layer of scrutiny to ensure that you can handle your mortgage obligations even under challenging circumstances. The stress test requires borrowers to qualify at a higher interest rate than the one they would actually be paying. Currently, the benchmark interest rate used for the stress test is the Bank of Canada's benchmark rate or the interest rate offered by your lender plus 2%, whichever is higher. This ensures that borrowers are able to make their mortgage payments even if interest rates rise in the future. Now, let's dive a bit deeper into how the stress test affects borrowers. The test applies to insured mortgages and borrowers who have a down payment of less than 20%. For these borrowers, they must qualify at the higher posted rate. For example, if the current interest rate for a five-year fixed-rate mortgage is 5%, the borrower would have to qualify at the stress test rate of 7%. This higher rate increases the monthly mortgage payment, which can impact your overall borrowing capacity. The stress test also applies to uninsured mortgages, which are home loans with a down payment of 20% or more. In this case, borrowers must qualify at a minimum rate of the greater of the five-year benchmark rate or the contract rate plus 2%. This means that even if you have a large down payment, you still need to prove that you can afford your mortgage payments at a higher interest rate. Why was the stress test introduced in Canada? The main goal is to protect both borrowers and lenders from potential financial risks. By ensuring that borrowers can still afford their mortgages during times of financial strain, the risk of defaults and subsequent financial instability is reduced. Additionally, the stress test helps to prevent homebuyers from taking on more debt than they can handle, which can lead to financial hardship down the line. It's important to note that the stress test has drawn some criticism since its implementation. While it does add an extra layer of protection, some argue that it has made it more difficult for first-time homebuyers to enter the housing market. This is because the stress test can lower the borrowing capacity of potential buyers, making it harder for them to qualify for a mortgage. It is even more important to note that since early 2022 we have seen the stress test protect against the exact situation that it was intended for and has undoubtedly protected those same potential buyers who unfortunately could not enter the housing market from financial difficulty. Overall, the Canadian mortgage stress test is a measure put in place to ensure that borrowers can handle their mortgage payments even in challenging financial situations or in the face of rising interest rates. While it has its pros and cons, its ultimate goal is to promote financial stability and protect both borrowers and lenders in Canada's housing market.