What's the mortgage stress test?

The federal government’s stricter new borrowing guidelines affect you if you plan to apply for a mortgage, and even if you already have one.

By now you’ve probably heard about the mortgage stress test that the federal government introduced in late 2017. But, if you’re like nearly half of Canadians polled recently by TD Bank, you may not understand what the test is—or who it affects.

“These new rules apply across the board,” says Ann-Marie Rasiawan of Mortgage Architects, a national mortgage brokerage based in Mississauga, Ont. “Even if you have amazing credit and a 20% down payment, you still have to go through the stress test.”

In other words, if you have a mortgage or plan to get one, the stress test applies to you. Here’s what you should know before you apply for your next home loan:

What is the mortgage stress test?

First off, it’s not really a test. Rather, it’s a more stringent set of rules banks must now use to determine if you qualify for mortgage and, if so, how much you can borrow.

Why was it created?

The new mortgage rules exist to protect borrowers, like you. Because interest rates have been at historic lows that can (and will) only go up, the government wants to make sure you’ll still be able to afford your mortgage payments when rates eventually do rise. Otherwise, if you can’t afford higher payments in the future, you might be forced to default on your mortgage and lose your home.

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, which is currently 5.34%. (Or, if the rate your bank is offering you, plus 2 per cent, is higher than the Bank of Canada rate, then that’s the minimum qualifying rate that will be used.) To put this into real terms, if you wanted to borrow $400,000 and the bank is offering you a rate of 3.5%, you would have to prove you can afford a mortgage payment of about $2,440 per month (at 5.5%), even though your actual monthly mortgage payment (at 3.5%) would be just under $2,000.

How does the bank determine what I can afford?

There are two main figures banks use in this calculation, Rasiawan says. “First is GDS [gross debt service ratio], which is the percentage of the borrower’s pre-tax income that will cover housing costs [including mortgage, heat and property taxes] and it should be no more that 32%,” she says. “Then there’s TDS [total debt service ratio], which is any outstanding personal debt [including mortgage, car loans, credit card debt, lines of credit, etc.] and should be no more than 40% of pre-tax income.”

Going back to our $400,000 mortgage example above, if we assume heating and property taxes total $560 per month (bringing total housing costs to $3,000), you’d need a pre-tax monthly income of at least $9,375 (or $112,500 annually) to have a GDS of 32% or less. Similarly, based on that income, your total debt load could not exceed $3,750 per month (including the $2,440 mortgage payment) to have a TDS of 40% or less in this scenario.

What do these new rules mean for borrowers?

If you are a first-time potential homeowner trying to get a foot into the market, the new rules make it a lot harder for you, Rasiawan says. “My brother, for example, was applying for a mortgage and under the old rules would have been able to qualify for $450,000 but can now only get $380,000,” she says. “That’s a huge difference when you’re a first-time home buyer.”

Renewing mortgage holders only need to “pass” the stress test if they switch lenders. “But they can’t really shop around for a better rate or negotiate with their existing lender when they renew, so it affects them as well,” she says.

Is there any way to side-step the stress test?

Not really. Canada’s big banks are mandated to enforce these rules while other lenders, such as credit unions, use them voluntarily to reduce their risk exposure. Still, there are steps borrowers can take increase home affordability, according to Rasiawan. “Save up more, pay down other debt or get a co-signer,” she says. “That will qualify you for a larger mortgage.”