This piece was originally published on June 1, 2021, and was updated on October 19, 2023.
Taking out a mortgage is typically the largest financial commitment many Canadians make – and in today’s rising rate environment, that can come with some significant risks. Following the steepest Bank of Canada rate hiking cycle in history over the last year and a half, payments have increased faster than anyone could have predicted for a large number of borrowers.
However, this risk has largely been mitigated by the mortgage stress test in Canada. This borrowing threshold is a way to prepare for the worst when it comes to rising rates eroding affordability — and it’s also a legal requirement in Canada.
But how and when are borrowers stress tested, and what is the criteria? Here’s what you need to know if you’re in the market for a mortgage.
What is the stress test for a mortgage?
In finance, planning for a worst-case scenario is called a stress test. It involves modelling a negative scenario before an investment is made. For example, let’s say you’re starting a retirement fund with an RRSP: While an annual return of 5% might be a reasonable expectation, what if your investments only make 4% each year? Will you still have enough money to retire at 60? If not, that RRSP has failed the stress test. You can use this information to make better investments and avoid costly mistakes.
A mortgage stress test is a way of determining exactly how much you can afford (and under what circumstances). If your income was reduced or you lost your job, could you still afford to make mortgage payments? What if interest rates spike or you need to refinance your home?
This type of rainy-day planning is important for a few reasons. First, interest rates and home prices fluctuate. We are currently in a rising interest rate environment: 5-year fixed and 5-year variable mortgage rates have gone from lows of 1.39% and 0.85%, respectively, in 2021 to 5.64% and 5.95% as of October, 2023.
This is because the Bank of Canada aggressively hiked its Overnight Lending rate 10 times between March 2022 and July 2023, bringing the benchmark cost of borrowing up 4.75 basis points, from a pandemic low of 0.25% to an even 5%. The bond market has also responded with rising yields – bypassing the 4.4% range – which in turn has pushed fixed mortgage rates higher over the course of last year.
Knowing you can still afford to pay your mortgage as interest rates remain high is important, and should affect the kind of home you decide to buy.
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What is the Canadian mortgage stress test?
Since 2018, all Canadian homebuyers getting a low- or high-ratio mortgage have been subject to a mortgage stress test, officially referred to as part of Guideline B-20. The mortgage stress test requires banks to check that a borrower can still make their payment at a rate that’s higher than they actually pay.
Here’s how it works. When you apply for a mortgage (including joint mortgages), you’ll be offered a contracted rate – hopefully, this will be as low as possible! However, your bank needs to check you’ll be able to pay back your mortgage, even if your mortgage rate rises during your mortgage term.
To do this, they check your ability to make your payments based on the Office of the Superintendent of Financial Institutions (OSFI) minimum qualifying rate (MQR), which is based on the mode average of posted 5-year fixed rates from Canada’s big banks, or your contracted rate plus 2%, whichever is higher.
The OSFI qualifying rate was 4.79%, but on June 1, 2021, the minimum qualifying rate increased to 5.25%. However, as a result of recent rate hikes, all contracted mortgage rates now exceed 3.25%, meaning all mortgages are currently stress tested at their contract rate plus 2%.
This means that your income needs to be high enough, and your existing debt low enough, to be able to pay down your mortgage at that higher rate. Generally, this will result in you being able to borrow a smaller amount of money.
UPDATE: On October 16, 2023, the Office of the Superintendent of Financial Institutions (OSFI) released its response to industry feedback to proposed changes for its Guideline B-20, the regulations that govern the lending and underwriting practices for Canada’s federally-regulated financial institutions.
As per their statement, a number of changes could be coming for borrowers on January 1, 2024, including a new loan-to-income ratio. However, the regulator will not tweak the criteria for existing GDS and TDS ratios, or exempt renewing low-ratio mortgage borrowers from being stress tested when switching to a new lender.
The banking regulator also revealed an exemption for high-ratio (transactionally-insured) mortgage borrowers; according to OSFI, this group is not subjected to the mortgage stress test when switching to a new lender upon renewal, as long as their original mortgage amount or amortization period as approved by their original lender does not change.
Read our post What changes are in store for Canada’s mortgage stress test? to learn more.
A mortgage stress test example
Let’s have a look at an example of the mortgage stress test. Let’s say the best mortgage rate in Canada is 5.24% and you must prove you could carry your mortgage at an additional 2% as per the stress test criteria. Even if you qualify for the lowest rates, you bank will run affordability calculations for two different mortgage rates:
- 5.24% (your contracted rate), and
- 7.24% (as per OSFI’s contract rate plus 2% criteria).
According to our mortgage affordability calculator, a Toronto buyer with an annual income of $100,000, a 20% down payment, and 5-year fixed mortgage rate of 5.24% amortized over 25 years would have qualified for a home valued at $523,308 under a 7.24% qualifying rate.
What if I fail the mortgage stress test?
If your income is too low to carry your mortgage payments at the higher stress test rate, or you are unable to prove you have a consistent source of income, you can fail the mortgage stress test, and your lender will refuse to provide you with the funds you need for your home purchase. In the event this happens, borrowers have a couple of options:
- Reduce the value of home purchase: Finding a home with a lower purchase price will result in a smaller overall mortgage and lower mortgage payments, which may be better within the borrowers’ ability to pay.
- Look instead to an alternative or B mortgage lender, who may be able to modify other elements of the mortgage, such as the total amortization length, to reduce the size of monthly payments. However, borrowers should be aware that these mortgage products come with higher interest rates than those offered by A -level lenders.
- Add a co-signer to the mortgage, who assumes the credit risk and responsibility of paying down the mortgage in the eyes of the lender.
Mortgage stress test changes
New mortgage stress test rules were introduced on June 1, 2021, that require all uninsured mortgages (where borrowers have a down payment of at least 20%) and insured mortgages (below 20% down payment) be approved at a higher qualifying rate of 5.25% or the contracted rate plus 2%. This higher qualifying rate decreases homebuyers’ purchasing power and reduces the amount of mortgage a household can qualify for by about 5%.
OSFI – which is Canada’s financial regulator – reviews the minimum qualifying rate on an annual basis, determining whether the current threshold reflects market conditions. In its most recent review on December 15, 2022, OSFI confirmed it would maintain its existing MQR criteria through 2023.
Do all banks do the stress test?
Under OSFI’s Guideline B-20, all federally-regulated financial institutions – including big banks, as well as federally-regulated credit unions, loan, and trust companies – must stress test all new mortgage applicants.
However, provincially-regulated FIs, such as some credit unions and alternative lenders, technically fall outside of OSFI’s B-20 mandate, and may not require stress testing on low-ratio mortgages.
Can you get a mortgage without the stress test?
In addition to seeking out a provincially-regulated lender that does not require the mortgage stress test, borrowers can also avoid it if they remain with their mortgage lender when they come up for renewal; most of the time, lenders won’t require an existing client be stress tested. However, borrowers will be subjected to the stress test if they refinance their mortgage, or take out a mortgage-collateral-based debt product such as a Home Equity Line of Credit (HELOC).
And, as mentioned above, if you're a high-ratio borrower, you can switch your mortgage to a new lender at renewal time without being stress tested again, as long as your mortgage amount or amoritzation period does not change.
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How to stress test your mortgage
So, changes to the mortgage stress test aside, how do you figure out what minimum monthly payment you’re required to be able to afford? Here’s what you need to know.
Increase the current interest rate
It’s one thing to compare the best mortgage rates on our site today, but you should also assume that mortgage rates could go up in the future. If you have a variable-rate mortgage, which is attached to the prime rate, rate increases would immediately affect your mortgage payments. If you have a fixed-rate mortgage, you’ll keep your current low rate for the duration of your term, but could be faced with an increase once your mortgage comes up for renewal.
While it’s impossible to predict exactly where interest rates will be in a few years, an increase of two to three percentage points isn’t out of the question.
For example, if you bought a home for $468,350 in 2018, put down 20%, and qualified for a 5-year fixed-rate mortgage of 2.89%, you’d have had a monthly mortgage payment of $1,752. That doesn’t sound so bad.
But what if your mortgage rate increased to 5.24% upon renewal in 2023, after your 5-year term ended? According to our mortgage payment calculator, your monthly payment would rise to $2,434. Can you afford that rate today?
If you couldn’t afford those payments, you may need to weigh your options. Do you save a larger down payment and defer the purchase of your home? Do you choose a more affordable home?
To run multiple scenarios on our mortgage payment calculator, you can also manually enter custom mortgage rates. Compare these results to your monthly budget before you buy a home that may be too expensive in the future. If you want to get serious about it, keep a spreadsheet with all the results so you can reference it later.
The bottom line
It’s important to keep up to date on changes to Canadian mortgage regulations, as they can directly impact your mortgage. Beyond that, the best thing you can do to increase the amount you can borrow is to earn more money and save more for a down payment.
It also doesn’t hurt to ask a mortgage broker for help when stress testing a mortgage before you buy. In addition to helping you find out what your ideal debt service ratios and maximum interest rate are, they can keep you up to date on changes to lending policies that can affect how much you can borrow.