In 2024, many homeowners find that having a mortgage is synonymous with feeling stressed. Ironically, this isn't the kind of stress that the 'stress test' refers to.
Owning a home has always been a major milestone accompanied by significant expenses. However, the stress and anxiety associated with this decision have significantly increased.
Just 3 or 4 years ago, skyrocketing property values and near zero cost borrowing created a hysteria in the real estate market with people racing to buy investment properties, remortgage, refinance and take out private loans to get into the real estate market. If you weren’t getting into the market, you were the exception.
Fast-forward to 2024 and the reality is entirely different. Canadians are overleveraged with housing debt with many priced out of home ownership entirely. Low supply and interest rates at levels not seen since the early 2000s likely means this situation will not change soon.
Against this backdrop, the Office of the Superintendent of Financial Institutions (OSFI) decided to revise the mortgage stress test guidelines with the latest update coming December 2022.
First introduced in 2018 by the Office of the Superintendent of Financial Institutions (OFSI) — a federal bank regulator, the concept of the mortgage stress test is simple. It’s a way to ensure that borrowers don’t borrow more than they can handle. Overborrowing is bad for the economy since it can lead to mortgage defaults.
The tests seek to determine if a borrower can still make payments if, for example, their income drops, or their expenses increase.
The mortgage stress test applies when purchasing a home, switching mortgage lenders, acquiring a homeowner line of credit, or refinancing your mortgage. It's not required, however, when renewing your mortgage with the same lender.
The Canadian mortgage stress test is designed to assess a borrower’s ability to manage loan payments at the higher of two rates: 5.25% or their contractual mortgage rate plus 2%.
For example, if a borrower secures a loan at an interest rate of 4.5%, the stress test will calculate their ability to repay the loan at a rate of 6.5%.
To conduct the stress test, lenders evaluate the borrower's income, debts, and various other financial obligations. They use this information to calculate the Gross Debt Service ratio (GDS) and the Total Debt Service ratio (TDS). The GDS, which includes housing-related costs, must not exceed 39% of the borrower's income. Similarly, the TDS, which encompasses all debt payments, must not exceed 44% of the borrower's income.
As you can imagine, the stress test has become an obstacle to homeownership—for better or worse. Many Canadians have had to adjust their initial strategies to pass the stress test by either reducing their home purchase budget (thereby lowering the loan amount and increasing their chances of passing the test), placing a larger down payment than they would have preferred, or adding a guarantor with good financial standing to the mortgage—like a parent, for example.
Others have not been so fortunate and remain on the outside looking in. For those unable to pass the stress test, alternative lenders such as PADS offer solutions. These lenders specifically help existing homeowners looking to purchase a second property or obtain extra financing to leverage their existing equity for a loan. These loans bypass the stress test entirely while still ensuring that borrowers can fulfill their loan obligations and make their payments on time and consistently.
In an ideal world, purchasing a home should be an attainable milestone. Unfortunately, for many, it has become a burden, or worse, a distant dream. The mortgage stress test is designed to ensure that those applying for a mortgage can afford to repay it, even in challenging economic times but due to its strict criteria, has left many Canadians unable to buy a property. There are alternatives. For those who don't pass the stress test, home equity loans are available. These can help Canadians build a real estate portfolio, pay down debt, and take control of their finances. Find out more here.
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