It’s OK, we’re here to help!
When most people think of a “stress test” they think of engaging in strenuous exercise to see how their heart performs under extreme conditions. In the mortgage world, a stress test applies a similar idea to the approval process—testing whether your budget can withstand a more extreme (higher) mortgage rate than current rate. The idea is to see if you will be able to afford your mortgage even under extreme conditions—a higher mortgage rate.
In mortgages, on October, 17th, 2016 there were new rules implemented. Finance Minister Bill Morneau announced new mortgage rules that will include more stringent ‘stress testing’ for borrowers. These rules stated that those with less than 20% down were tested, HOWEVER, starting Jan, 2018…all borrowers will need to stress test!
What is a stress test and what does it mean for you?
Stress testing is a risk management tool, it is a way of determining exactly how much you can afford and under what circumstances. It is also a way for you to plan for the future. The stress test helps figure out what your maximum monthly payment could be and see if you can still afford your mortgage payments, even if interest rates increase.
The stress test is designed to simulate your financial situation by assuming you would have to pay back the loan at the posted average, not whatever deal you were able to negotiate. The present “stress test rate” is at 4.89% – which is based on the Bank of Canada posted bond yield. Mathematically, this has the effect of lowering your approval amount by approximately 18.7% reduction.
For example: if you were pre-approved for a refinance or a purchase of $500K mortgage in Oct of 2017, after Jan 1 2018 your approval would be reduced to approximately $407K!
With this information you as a homeowner can budget and make a proper decision as to what type of mortgage is best for you.
Who needs a stress test?
Currently the stress test is needed for those who are seeking an insured mortgage through the Canadian Mortgage and Housing Corporation (CMHC) for a buyer putting down less than 20 percent.
Starting Jan, 1, 2018 the new rules include home buyers who don’t require mortgage insurance (because they have a 20 percent down payment). They too will also have to prove they can make meet their commitment, if interest rates rise above the five-year benchmark rate or 2 per cent higher than their contracted mortgage rate, whichever is higher.
“Stress tests are used by financial institutions to gauge how their business would fare under extremely difficult conditions. They provide a formalized mechanism for companies to look at risks and to assess the impact of the different extreme events. “
Essentially, the mortgage stress test requires those who are applying for a mortgage to show they can afford to pay it back. (Joking aside, if you’re thinking of refinancing…NOW is the time if you’re concerned about accessing full equity!)