While I believe there is some benefit of the stress test rate (currently the higher of 5.25% OR your rate +2%, to qualify for a mortgage), in 2024 with higher mortgage rates, buyers need an edge. This article will show home buyers and those looking to renew their mortgage, how to reduce the mortgage approval limiting impact of the stress test and get further ahead with their mortgage and purchase.
But First very quickly – How does the Stress Test Work?
The stress test is essentially a high interest rate that is used on a mortgage application, that a mortgage broker or bank will use to qualify you. It is calculated as the higher 5.25%, or your rate + 2%.
So for example, if you have a variable rate approval of 3%, then the stress test rate will be 5.25% because 3% + 2% is 5%. However, if you have 4% fixed rate, then the stress test rate is 6% because 4% + 2% is higher than 5.25%.
The stress test rate is not a real interest rate that you see on a mortgage approval document, or that your payments would be based on. Instead, it is an artificially high rate that is literally made up to lower the amount of mortgage you qualify for.
Specifically, the stress test rate lowers mortgage approvals by about 20%.
So for example, let’s say you were to qualify for $500,000 of mortgage using an interest rate of 2.25% for 5 years fixed.
Using the stress test rate of 5.25% (a 3% higher rate than the actual mortgage rate your payments are based on), your maximum mortgage qualification would be lowered to $400,000. In other words, by qualifying you at 5.25% instead of the contract rate of 2.25%, this reduces your mortgage approval by about $100,000.
Clearly, this impacts how much home you would be qualified to buy.
Reducing the Impact or Avoiding the Mortgage Stress Test
There are thankfully a few loopholes that can help you to reduce the impact of, or even avoid the mortgage stress test.
Buying a Home
Bank lending exceptions
If you have 20% down payment or more, the bank can be more flexible with your application, because it is not restricted by CMHC insurance guidelines. More specifically, if you have good prospects for increasing income, excellent credit, and some savings/investment left in the picture after purchase, the Banks can potentially make an exception to lend you more than their typical limit would call for.
Its certainly not always a shoe-in deal, but at Altrua Financial, we have substantial experience in structuring applications for Banks to increase their lending limits and make exceptions, if required by the borrower.
Credit Union Approval
Interestingly, because credit unions are not federally regulated, the stress test does not apply to many of their mortgages. For a mortgage with less than 20% down payment, the stress test will always apply, because there would be a CMHC insured or ‘high ratio’ mortgage. However, if 20% is available for down payment, then the credit union can qualify you at their contract rate, and even at a 30-year amortization as well. The result can be a much higher pre-approval.
At Altrua Financial, mortgage brokers, we work with many credit unions and can find you the best approval on a NO-stress test mortgage.
But what’s the catch? Unfortunately, there is not an excess of funds available for these types of mortgages, so the rate can be a little bit higher. Typically, the rate is about 0.50% higher. For some borrowers, the thousands of dollars in extra interest costs are not worth it. However, for many, it may be worth it if it helps into the home of their dreams and the payments are affordable. Indeed, relatively speaking, the housing values are increasing at 10% regularly – the slightly higher mortgage rate may be lesser of an impact, or may be justified accordingly – subject to market conditions.
30 Year Amortization
By opting for a longer 30 year amortization, you can lower your payments and be approved for more mortgage. Even if you want to pay your mortgage off sooner, for example in 25 years, 20 years or even 10 years, you can still obtain your approval with a 30-year amortization and then increase your payments, using pre-payments after closing to reduce the effective amortization. This move can increase your approval amount by approximately 15%, significantly offsetting the effect of the stress test. However please note that the 30-year amortization is only available for 20% or more down payment.
Gifted Down Payment
With parents, grandparents or other immediate family in the picture, down payment can be gifted. By increasing the down payment this can allow you to buy more home, with less mortgage in the picture. Also, if you can get up to 20% down payment, then as noted just above, you can stretch the amortization to 30 years, or work with a leading credit union, and really extend affordability. However, even an extra 5% – 10% added to the down payment, in the form of a gift, can make a notable difference in the price range of your pre-approval. As long as the down payment is from an immediate family member, the rules are fairly relaxed at this point of time. See our article here on down payment specifics.
Co borrower
Perhaps instead of a gift, or in combination with a gift, a co-borrower can be added onto a mortgage to help boost affordability and mitigate the effects of the stress test. The co borrower again should be immediate family and should be in a fairly strong position with little to no debt of their own and a stable, full-time income. As far as a pre-approval goes, the sky is the limit, as would be in line with the strength of the co-borrower.
Renewing a Mortgage
When renewing a mortgage, if you get stuck due to the stress test rate make sure you or your Ontario Mortgage Broker or lender are considering the following.
Purchase before 2017
If your purchase was before 2017 then the stress test will not apply to you. Your renewal will qualify at the standard contract rate.
Purchase after 2017, under $1,000,000
If the purchase was after 2017 but the purchase price was less than $1,000,000 then the new lender may be able to qualify you at much lower, insurable rates. Even if the current value of the home is over $1,000,000. However, avoiding the stress test rate, in this case, maybe more difficult.
Stress test 2022 Rules Update
In 2022 the Federal Government of Canada is supposed to increase the limit noted above to $1,250,000 – however with increases in housing prices we will see if this comes true.
When the stress test was first implemented in 2017, the rate itself was literally just arbitrarily set by the Federal Government.
Now in 2020, the rules have changed so that the stress test rate more closely reflects the actual interest rates in the Canadian mortgage market. In other words, the rate is no longer arbitrarily set, but it it will now float based on actual market interest rates.
So while the effects of the stress test are mostly the same, the idea that the stress test can now move down as market rates move down is a more fair and accurate idea of what a stress test should be.
This does help the homeowner afford more home, although so far since the rules have changed – not by too much. The average mortgage applicant may not get an extra $10,000 – $25,000 in a mortgage approval, depending of course on the mortgage size.
