25 Jul Can I pass the mortgage stress test?
Ever since its implementation in January 2018, the mortgage stress test has been itself a source of stress for many potential homebuyers. Now, anyone who needs to qualify for a mortgage from a regulated lender needs to take this test. Again, just to review, this stress test is a calculation used to determine if homebuyers can keep up with their commitment to mortgage payments in case interest rates were to rise. Until January 2018, only those potential homebuyers putting less than 20 percent downpayment were required to take this test. (For more on the stress test, check out our blog post on this topic).
It is also important to understand that this stress test was created to protect borrowers, like yourself. Due to the historic lows we’ve had in interest rates, the government wants to make sure you are still able to afford mortgage payments once these rates go up (they are at their all time low). If you can’t meet payments, you may have to default on your mortgage and, obviously, lose your home. (Again, check our post on this topic).
How does it work?
When you apply for a mortgage, the lowest rate the bank can use to determine your eligibility is the posted Bank of Canada five-year rate. Or, if the rate your bank is offering you, plus 2 percent, is higher than the Bank of Canada rate, then that’s the minimum qualifying rate that will be used. If you have less than 20 percent, you will default to an insured mortgage. This will also be calculated against the Bank of Canada’s rate or the rate offered by our lender.
It is very important to remember that if you already have a mortgage and need to refinance, you are only exempt from the test if you renew with the same lender. Otherwise, you will have to go through the stress test.
How do banks know what I can afford?
Well, they look at the total debt service ratio, which can be, for instance, a monthly debt obligation, such as a credit card payment. They also analyze the gross debt service ration, which is the percentage of a person’s income needed to pay all of their monthly housing costs. You can do this by using the PITH formula (Principal, Interest, Taxes and Heating). So, add up the amount of principal you pay each month with interest, property taxes, heat and 50 percent of condo fees (where applicable) and then divide this by your gross monthly income. To find out total debt service ratio, take the PITH calculation, add 50 percent of condo fees if you have them, and all the other monthly debts you have. Once you have this total, divide it by our gross monthly income.
At the end of the day, you should aim for a mortgage that is no more than four times your income. Keep in mind that in cities like Toronto nowadays you need an income of about $100,000 to be able to afford the average home. As usual, we are here to assist you with the process.