It is important to know what you can safely afford when you are shopping for a house — what your limit is and how you can plan for the future. With interest rates expected to increase, you do not want to find yourself trapped in a mortgage you cannot afford. Mortgage stress tests are used to keep homeowners from over-extending their finances.

What is a mortgage stress test

First of all, you might be wondering what, exactly, is a mortgage stress test. Whether you are a prospective homebuyer, or a current homeowner whose mortgage will soon be up for renewal, you should be aware of the effects the stress test can have on your ability to be approved for a mortgage.

The purpose of the mortgage stress test is to assess whether you would still be able to make your monthly mortgage payments should interest rates increase in the years to come.

As of January 2018, even those who put a 20% down payment towards a home will have to undergo a mortgage stress test. Prior to this change, only those who were putting less than 20% down were required to take the test.

How does it work

If you have 20% to put down on a home, the mortgage stress test qualifying rate would be the rate offered by your lender plus 2% or the Bank of Canada’s five-year benchmark rate, whichever is higher.

This percentage is used to determine whether or not you would be able to afford the new monthly mortgage payment if interest rates were to increase.

Now if you have less than 20% to put down, your rates from a lender are typically higher, so your mortgage stress test qualifying rate would be different. It would be calculated using either the Bank of Canada’s five-year benchmark rate or simply your lenders’ rate, without the 2% increase, to calculate the potential monthly payments. Again, the higher of the two is chosen.

Because of these mortgage policy changes, the amount for which you can be approved for will be lower than it was previously. But, as more interest rate hikes are expected in the future, you will be safer in the long run, which is the goal.  

Fixed or variable mortgages

People with fixed mortgages might feel quite safe, but the mortgage stress test can affect you as well. Those renewing their mortgages with the same lender will not need a new qualifying rate. If you decide to change lenders or to refinance then a mortgage stress test is required to determine a new rate.

Anyone with a variable mortgage knows to watch interest rates and they will be affected immediately following an increased rate.

Take the time to determine what you can safely afford and how you can set yourself up for success in the long term. While the stress test may reduce the amount of homes that you can afford, the mortgage stress test is designed to protect Canadians from over-extending their finances and falling into a trap down the road.