How Canada’s Mortgage Stress Test Affects You

You’ve heard about the changes to mortgage rules. Now we explain what it means for prospective Options For Homes purchasers.

As Canadians ushered in 2018 with cheer and hopeful resolutions, the federal government rang in the New Year with a resolution of its own: to protect Canadians from amassing too much household debt. And so, the requirement for potential homebuyers to pass a mortgage stress test was announced.

The measure, which requires people to qualify for a mortgage at the current rate plus 2%, came amid a climate of record personal debt, overheated housing markets, and the return of increasing interest rates. The purpose is to ensure that those buying a home have the financial bandwidth to withstand interest rate hikes, something homeowners have been spared for nearly a decade.

The effect, however, is that your purchasing power – meaning the amount that can be borrowed for a mortgage – has been reduced. Told another way, it means that households now need a higher income to qualify for the same mortgage amount they would have qualified for before the new rules.

So what does this all mean for prospective Options for Homes purchasers, especially those who might be taking the Down Payment Loan (DPL)? We busted out the calculator and crunched some hypothetical numbers to help paint a clearer picture for you.

Let’s assume you’re looking at a small unit with a purchase price of $300,000. You’ve got a 5% down payment and are taking the Options DPL of 15%*. How much of a mortgage do you need?

Purchase Price: $300,000
5% down payment: $15,000
15%* Options DPL: $45,000
Mortgage required: $240,000

In the past, this size of a mortgage could be secured on a household income of roughly $56,000. Today, you’d need about $63,500. Of course, this wouldn’t affect the actual price of the unit, carrying costs, maintenance fees and taxes. It just means that the government wants to ensure you’re not so close to your financial limit that you couldn’t afford your mortgage if anything changed.

What does this look like if you’re hoping to purchase a larger, family-sized unit? Let’s assume a two-bedroom plus den was available for around $500,000. You’ve got a 5% down payment and are taking the Options DPL of 15%*. How much of a mortgage do you need?

Purchase Price: $500,000
5% down payment: $25,000
15%* Options DPL: $75,000
Mortgage required: $400,000

In the past, this size of a mortgage could be secured on a household income of roughly $93,000. Today, you’d need about $107,000.

While the stress test might seem like a bad thing, in fact, it’s a good way to make sure you can really afford the home you want to buy. Even without a mandated stress test, prudent homebuyers leave room in their finances to prepare themselves for fluctuating interest rates, unexpected life events, and inevitable home repair costs. Factoring an extra 2% is a good way to do that.

One interesting detail about the stress test is that credit unions are not currently bound by this requirement. Still, Nick Eddy, Bloor West Village branch manager at Meridian Credit Union, an Options For Homes lending partner, considers the new rule a “common sense lending approach.”

He advises clients looking to purchase a home to use the “rule of thumb” of borrowing no more than four times your annual household income for your mortgage. So if your household income is $80,000, you’d be looking in the $320,000 range. He also encourages people to be realistic. If the stress test suddenly makes securing a mortgage out of reach then “maybe now isn’t the right time for you to purchase and to keep saving,” says Nick.

“While we definitely want to help people realize their dream of homeownership, it’s a case of making sure you’re ready for everything that comes along with homeownership, which includes interest rate fluctuations.”

To make sure you’re ready, Nick recommends these three rock-solid home-buying preparation tips.

Limit the luxuries

“Make sure that you, as an individual, have done a budget for yourself. Do you have to go to Tim Hortons or Starbucks every day? There’s $20 to $50 a week you could save. Do you have to have the best new cell phone? That’s the other thing for people to really consider when they’re looking at buying a house or condo: what don’t you need. Are you willing to go out for dinner or get take out only once a week instead of three?”

Build in a buffer

“I think stress testing is a good thing from a budgeting perspective because people are worried about not being able to afford a property but at the same time, if rates do go up – and rates are rising now where they’ve been historically low for years – you’ve got to be able to comfortably afford to pay for the roof over your head. Adding a buffer is a good idea, even if you’re going through a lender that’s not affected by these changes. When you find a rate that’s average add 1-2% to that and see what that does to your monthly commitments because every five years, maybe the rate increases as do your monthly expenses.”

Prepare for the unpredicted

“Factor in other costs of homeownership. When you rent, your rent includes taxes and other things like repairs that your landlord pays for. When you own, these are costs of homeownership. Then there are things like lifestyle changes – maybe another child comes along or there’s a layoff in the family and you have to support the mortgage payment on one income. You need to be ready for that.”

To discuss your mortgage needs contact Nick Eddy at Nick.Eddy@meridiancu.ca.

*Down Payment Loan percentage is only an estimate. Actual percentage varies by development.