Borrowing capacity – What is a mortgage rate stress test?
by Denis Doucet
What you’ll learn
- What is a stress test?
- Why are financial institutions doing stress tests?
- Other tools & resources to avoid over-indebtedness
When you want to borrow money to purchase a property, specific data is analyzed by your mortgage broker and lender to determine your borrowing capacity. And before they approve you for a loan, the financial institution must accurately predict that you will be able to financially keep up with your mortgage payments if interest rates were to rise.
The term used for this process (now mandatory for all new insured residential mortgages) is a mortgage rate stress test. This stress test (if you will) is not an actual test that you need to pass. It is a simulation that lending institutions use to predict whether you not only qualify for financing at the negotiated rate in your contract, but also the Bank of Canada’s conventional five-year fixed posted mortgage rate (4.64%). This rate is an average of the posted rates of the big six banks in Canada, and is usually higher than what home buyers can negotiate with individual lenders.
The lender will calculate a reference rate, and determine if you would still be able to repay your mortgage in the event of an increase. The results of this test will determine the amount that you can borrow from a lender. That’s if you qualify (institutions cannot extend financing if your criteria fails the test). Note, a stress test is now used for approving all insured mortgages. If your down payment is at least 20% or more, a stress test is not mandatory with some lenders. That said, if you have at least 20 per cent to put down and pass the stress test, you could enjoy a mortgage rate discount.
What is the purpose of conducting a stress test? To ensure that you will be able to continue making mortgage payments in the event of a rate increase – particularly when your mortgage is up for renewal.
How to avoid over-indebtedness?
During the holidays, it’s easy to get carried and over-extended financially. However, if you’re struggling to keep up with daily expenses, non-professional debt and financial responsibilities month after month, these handy tools and resources can help ensure your financial wellness!
First, check out our handy resources to assess your borrowing capacity, not to mention our new online application to pre-qualify for a mortgage.
Then, be sure to read Fabien Major’s insightful and relevant piece, “The Three- drawer Strategy for maximizing your budget“!
And, to ensure you get the right product from the right lender that best suits your personal situation and mortgage needs, you always can contact an experienced Multi-Prêts broker directly or attend one of our complimentary workshops across Québec.
- The mortgage rate stress test is a way of determining exactly how much you can actually afford to borrow (and this is the important part) under what circumstances. For example, if interest rates spike will you still be able to make your mortgage payments.
- The stress test gauges your repayment capacity against the Bank of Canada’s benchmark rate.
- The Multi-Prêts site has the tools and resources to help you better plan your financial wellness and future.