Since its introduction by the
Canadian Government in late 2017, mortgage stress testing has been met with mixed reactions.
Although a well-intentioned policy to ensure Canadian home buyers aren’t stuck
in a house whose monthly mortgage payment they are unable to meet up with,
mortgage brokers and lenders argue that these new rules are slowing down
mortgage lending in Canada, especially in prime real estate markets such as the
Toronto and Vancouver areas.
Can you pay your mortgage comfortably if the interest rate
This is the one question which mortgage
stress testing was made to answer. As interest rates are
still currently at an historically low point and they might rise sometimes in future, there’s a need to
test your financial capability to pay this potentially higher mortgage in the
future, as if you are unable to do so you’d be forced to default and
consequently, lose your home. It should be noted that if an interest rate jumps
from 3% to 5%, the total lifetime cost a $450k mortgage with an amortization of
25 years will jump from $659k to $810k according to Wowa monthly mortgage payment calculator. This means that the lifetime interest
cost of the mortgage will increase from $195k to $346k for the same mortgage.
Hence, this new mortgage rule was
put in place to protect a borrower from taking on more debt in form of
mortgage, than is commensurate to the person’s monthly income.
When you apply for a mortgage, yourmortgage affordability is determined using the higher rate
of either the Bank of Canada’s five-year rate which is currently at 5.19% or
the rate your bank offers plus 2%- whichever rate is higher is taken as the
minimum qualifying rate to determine your
mortgage eligibility. You can check how much mortgage you can afford by
using Wowa comprehensive mortgage
affordability calculator in which the affordability is calculated based on seven
models; all big five Canadian banks, CMHC as well as Wowa advanced model.
Banks mainly calculate how much an
individual can afford by either using theGross Debt Service
i.e. the percentage of a borrower’s pre-tax income that covers housing costs
e.g. heat, lighting, property taxes; or theTotal Debt Service
which covers for outstanding personal debts such as credit card debts, car
loans, mortgage etc. To qualify, the GDS must not be greater than 32% while the
TDS should also be less than or equal to 40% of pre-tax income.
The Impact of Mortgage Stress Testing
According to CMHC’s Residential
Mortgage Industry Report, regulatory changes such as mortgage stress testing
have resulted in a drop in the number of housing transactions conducted e.g.
transactions dropped by 11% in 2018 and housing prices dropped by 4% and
altogether, this resulted in a 19% decline in demand for mortgages.
In the same vein, there was a
decline in insured mortgages, with there being 16% more uninsured mortgages at
the end of 2019 than there were in 2015 before mortgage stress testing.
Also, because current homeowners are
trying to avoid being subject to the stress test, they have been noted to stick
with the same lender (renewals increased by 16%, while refinancing rate was
While the stress test benchmark rate
used to be at 5.34%, it dropped to 5.19% by July 22nd 2019 and by
April 6, 2020 the benchmark rate will be calculated by the Bank of Canada using
weekly median 5-year fixed mortgage rate and an added 200 basis points. It is
expected that the calculated new mortgage will be roughly equivalent to the
current benchmark of 5.19%, the only difference being that this new rate will
fluctuate weekly. Hence, there is a need for continual monitoring especially if
you would soon be undergoing the stress test.
Watering down the mortgage stress
test might not be in the interest of the government of Canada when there are
many homebuyers who have a high debt to income ratio, or who for whom increased
interest rates could lead to them becoming mortgage defaulters. Regardless,
with a recession looming, the mortgage stress test would have a reduced
benchmark rate, giving more freedom for purchase by homebuyers.
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