There were some recent changes to mortgage stress test rates that occurred June 1st, 2021. These updates can affect your mortgage affordability and current purchasing power.
This change affects the uninsured mortgage stress test, so it affects those who are putting 20% or more down on their homes. The mortgage qualifying stress test is a safety measure, put in place for both buyers and lenders.
It ensures that borrowers will be able to make payments at higher mortgage rates or lower salary levels than what they currently have. It is done to ensure that a buyer can continue to make their mortgage payments without defaulting if there are changes in their personal circumstances or changes in the current rates.
If you are looking to buy a home in Canada, you need to be aware of the new stress test rules and understand how they will affect your buying power.
What are the new mortgage stress test rules?
The new stress test was implemented in an attempt to cool the hot Canadian housing market.
However, not everyone sees this as a positive move – the change has upset many potential buyers because the mortgage stress test directly correlates to their buying power.
As buyers are tested at higher rates (5.25% or their rate +2% – whichever is greater), it limits what they can borrow and afford. You’re looking at about a 4%-4.5% reduction in what you could qualify for previously in 2020.
It’s not significant but it certainly will affect those who are buying for the first time or those who are just putting enough downpayment in to get to that 20% threshold, that don’t have additional cash to fall back on for additional buying power in their downpayment.
Contrary to popular belief, you don’t qualify at the mortgage rate you are getting, you actually need to qualify at a higher rate to make sure that if rates do go up you’ll still be okay and be able to make your mortgage payments.
Example Calculation
So for every $100,000 that you’re borrowing in your mortgage it will be $4000 less than you are able to afford. So if you pre-qualified for $400,000 pre the changes, now you’ll have $16,000 less in your purchasing power.
$16,000 may not seem like a big number, but for those who cannot rely on generational wealth or those who could just make the 20% downpayment, it makes things particularly tight, especially when you consider the added costs of buying, such as property transfer taxes and legal fees.
Why is the stress test being changed?
The change to the stress test was made this year, largely as a preventative measure to help support our post-pandemic economic recovery.
It ensures Canadians are borrowing less and are therefore taking on less debt if inflation eventually causes rates to rise. This is a safety measure as we move towards strengthening the economy, which suffered as a result of the pandemic. With less debt and higher rates, those that purchase will be prepared for uncertainty in future rate changes.
It’s also a way to help cool the hot housing market that left many Canadians unable to buy in 2020 due to high demand, limited inventory and subsequent bidding wars.
Who will these changes affect?
The change is most likely to affect middle-class families in Canada. Those who may be looking to upgrade from their starter home or condo and wanting something a step up from where they currently are.
To a lesser extent, it will affect first-time homebuyers who are looking to put in 20% down or more. For those on a tight or set budget, the new stress test is a blow to potential buying power. First-time home buyers without the bank of mom and dad are already facing inflated prices – an existing barrier to entry into the market. These changes mean they risk being priced out of a home entirely.
How will the new rules affect the housing market?
It is possible that the new stress test rules will have the intended effect on the market and cool things down to normal levels again.
It’s also possible that they will have the adverse effect and actually negatively affect the housing market. Those who are looking to upgrade from their first properties may choose to stay and wait it out, rather than purchasing in 2021. This means that there will be less available inventory on the market for first-time buyers.
It is too soon to tell as the rules were implemented recently, however, the more data we have we will be sure to update you.
What about Kelowna and the Okanagan?
In Kelowna and the Okanagan, the new stress test rules will likely not make a significant impact on buyers. If you are working with an experienced mortgage broker in the Okanagan, there are many things they can do to help you buy what you want, despite the new rules in place.
The experts at Rampone-Marsh have excellent, local experience. Our team knows the local market and can help you navigate to get the best possible rates and loan for your home.
Can you avoid the mortgage stress test?
A good mortgage broker will know the loopholes to help lessen the effect of the stress test on your mortgage. There are also some ways to avoid the test altogether, however there can be some caveats to doing this.
Get a 30 Year Mortgage
Most conventional mortgages are 25 years long, but some lenders offer 30 year mortgages. Because these mortgages are spread out over a long period of time, your monthly mortgage payments will be lower and you will be eligible for more in your mortgage. The downside to this is that you will likely end up paying more interest on your mortgage, but in some cases, the pro of being able to afford the home you want outweighs the slight increase in interest.
Pay a Higher Downpayment
Whether you are able to have part of your downpayment gifted from family, or you simply take some more time to save, a higher downpayment is a great way to get around the stress test rules as you will have more cash on hand to put into your home.
Co-Sign Borrowers
There is some risk to this, however, in many cases, buyers will have a trusted family member or spouse sign on with them as a co-sign. The co-signer should have a high credit score to boost the borrowers rank. With the co-sign, they are liable for any defaults in your mortgage, so the banks and lenders know that if you default, there is a second person they can go to for payment. In reality, defaulting does not happen often, but lenders like the security that comes with a credible co-sign and can have you approved for better rates and a higher mortgage as a result.
Work With an Experienced Mortgage Broker
At Rampone-Marsh, we have options for Okanagan lenders that avoid the stress test completely. If you as the client have 20% down on a purchase, we can use the contract rate (2.39% for example) instead of needing to qualify at the higher rate of 5.25%. This is a major advantage for borrowers looking to increase their qualifying amount who have a 20% or more down payment! I can get into details regarding the lenders, but we do a fair amount of business with them. It can often add up to a $100,000 increase in purchasing power for a strong applicant. Contact us to learn more.
What can I do to purchase what I want despite the mortgage stress test?
Despite what it may seem, every mortgage situation is unique and all is not lost when it comes to your buying power. There are a few things you can do beforehand in order to prepare for the mortgage stress test and help banks and lenders see that you are credible.
All lenders use a few key metrics to determine whether or not borrowers will pass the stress test. They want to see your gross debt service ratio(GDS), as well as your total debt service ratio (TDS). These metrics indicate how much existing debt you have and how much you will be able to take on with a mortgage.
GDS
The GDS calculation takes into account your pre-tax income and calculates the amount you need to pay housing-related costs. Your lender does not just look at the cost of your monthly mortgage payments, they look at all housing-related expenses you’ll be paying such as strata fees, electricity, hydro, property taxes etc. The total housing costs will be added up and divided by your pre-tax monthly income. If the percentage of housing costs is over 32% it will be harder for you to get a loan.
TDS
The TDS calculation takes all of your existing debt into account. It looks at the percentage of your gross monthly income you’ll need to pay off debts. Debts include student loans, car payments, lines of credit, credit cards, and more. These should not exceed 42% of your total income in order for you to get approved.
Pay Off Debt
If you have any existing debt and the ability to pay it down, doing so could greatly improve your chances of passing the mortgage stress test. The total debt service ratio takes the amount of money you owe directly into account when assessing your mortgage affordability. So paying off old debts is an excellent way to improve your chances.
Build Good Credit
Many lenders will give preferred rates to those with a good credit score. If you are unsure of where your score stands, talk with your mortgage broker about getting a credit check. Checking your credit score can temporarily lower the score, but your mortgage broker can do a ‘soft credit check’ which may not have an effect on the number. Once you know where you stand, work to slowly build your credit. If there are existing penalties on your score, you can work to resolve them, or call the credit bureaus to refute them.
The Bottom Line
Ultimately, the new mortgage stress test rules can hinder buyers from getting the mortgage they want. However, with the help of an experienced mortgage broker, there are still ways to get the funding you need to buy the home you want. At Rampone-Marsh, our team of certified mortgage brokers can help assess your individual situation, and give you the best advice to help you reach your home buying goals. We offer a variety of mortgages and can work with you to find the best solution.
Our connections to lenders in Kelowna and the Okanagan help get you the cost-effective mortgage you want, at competitive rates, despite the new stress test. Getting a mortgage does not have to be complicated, click to contact us today!
