How does the rising stress test impact mortgage affordability?

Jordan Lavin

October 30, 2023

This post was originally published on June 1, 2022, and was updated on October 30, 2023.

As interest rates have steadily marched higher over the past year and a half, so too has the mortgage stress test – and it is shrinking the amount of mortgage borrowers can qualify for. What does a rising stress test mean for you and your homeownership dreams? Let’s take a look at the mortgage stress test and how it affects mortgage affordability.

What is the mortgage stress test and how is it used?

When you get a mortgage, the lender wants to be confident you can make your payments. One of the calculations they use to do this is called your debt service ratio, which compares your housing costs and other debt payments to your income. Mortgage lenders usually want your gross debt service ratio (the cost of housing including your mortgage, property taxes, condo fees, and heat) to be no more than 39% and your total debt service ratio (the cost of housing plus all your other payments) to be no more than 44%.

What is the relationship between mortgage rates and the stress test?

As mentioned above, the qualifying rate you’ll be stress tested against is the higher of 5.25% or your contracted mortgage rate plus 2%. Until recently, discounted mortgage rates were low enough that almost everyone was stress tested using a qualifying rate of 5.25%, but thanks to a sharp rise in mortgage rates more Canadians are being subjected to an even tougher stress test.

For example, if you were to get a five-year fixed mortgage with today’s best rate of 5.64%, your lender would calculate your debt service ratios using a qualifying rate of 7.64%. In fact, many of today’s borrowers are being stress tested in the 8.2% range and above, based on the average five-year fixed rate currently available on the market.

Also read: Home affordability declined in September as stress test hit new high

What do higher mortgage rates mean for your ability to afford a mortgage?

When you pay a higher mortgage rate, your monthly payment has to increase to cover the additional cost of borrowing. As a result, the maximum mortgage amount you’ll qualify for is reduced as rates rise.

Let’s say you have a household income of $100,000 per year. To stay within the maximum 39% gross debt service ratio, your total housing expense can be no more than $3,250 per month. Assuming your additional housing costs are $1,000 per month, that leaves you with $2,250 per month for your mortgage payment.

If you were qualified at today’s best mortgage rate of 5.64%, you could afford a purchase price of $454,161 with a down payment of $50,000.

However, because your minimum qualifying rate would be 7.64%, you would actually qualify for a purchase price of just $387,670.

If mortgage rates were to rise by yet another 1%, your maximum affordability would fall to just $360,771 – a drop of $26,899.

Qualifying rate	Maximum purchase price
5.64%	$454,161
7.64%	$387,670
8.64%	$360,771

Is the stress test itself getting tougher?

Rising interest rates are eroding mortgage affordability, and pushing the stress test to new highs. As the lowest five-year fixed and variable mortgage rates are currently in the upper 5 and 6% range, most borrowers are being stress tested at a minimum of between 7 - 9%.

OSFI, the regulator that sets the mortgage stress testing rules, reviews the policy on an annual basis. In its last review on December 15th, 2022, OSFI chose to keep the minimum qualifying rate at 5.52%. However, this coming year, the banking regulator is doing a fulsome review of its B-20 guideline, of which the stress test is part of; it may choose to tweak the MQR further in January 2024 as part of this review, or leave it unchanged.

Do I need to worry about the stress test if I already own a home?

The stress test is largely meant for new mortgages. If you already own a home and have a mortgage, you won’t be subjected to the stress test if you decide to renew with your current lender. If you want to refinance your mortgage or switch to a new lender, however, the stress test will apply if you are a low-ratio borrower (have paid more than 20% down).

However, in a recent feedback update released on October 16, OSFI clarified that high-ratio, transactionally insured mortgage borrowers are not stress tested should they choose to switch to a new lender upon renewal, as long as their original mortgage amount and amortization period does not change.

Read more: What changes are in store for Canada’s mortgage stress test?

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How can I maximize my mortgage affordability despite the stress test?

Raise your income: It’s easier said than done, but making more money can help you qualify for a bigger mortgage.Sometimes, it can help just to have your income look bigger on paper. For some reason, lenders only like income that comes from annual salaries. Hourly wages, commissions, bonuses, and self-employment income don’t get the same consideration. If you have the option to trade these kinds of income for a bigger salary, it can help you look like a better candidate to the banks.
Save a bigger down payment: Making a larger down payment reduces the amount you need to borrow, and helps you save money on mortgage default insurance (often called CMHC insurance).
Get a mortgage pre-approval: If you’re planning to buy a home in the next three or four months, getting pre-approved for a mortgage can help you shop with confidence. When you apply for pre-approval, your mortgage broker or lender will look at your financial situation and guarantee a maximum purchase price and interest rate for up to 120 days. If rates go down before you complete your purchase, you’ll get the lower rate. If rates go up, you’ll still get the rate you were pre-approved for.
Start with a variable-rate mortgage and convert to a fixed rate: Traditionally, variable mortgage rates are lower than fixed rate options – but that isn’t the case today, with the lowest variable five-year term starting at 5.95%, compared to 5.64% for a fixed rate. Should that reverse in the future, however, borrowers may want to try the strategy of taking out a variable-rate mortgage first to utilize the lower stress test rate and then converting to a fixed rate (with the same lender) after closing without having to pass the higher fixed-rate stress test. There is no penalty for doing this.

Use caution with this method, because your lender can raise your mortgage rate at any time. Make sure you convert to a fixed-rate mortgage as soon as you can to avoid a situation where you’re potentially unable to afford your mortgage payments.

Also read: Think mortgage rates will drop? The argument for getting a variable rate now

The bottom line

The mortgage stress test is a useful tool to make sure you won’t be caught off guard by rising interest rates. Prepare yourself for a future with higher mortgage rates by saving a larger down payment and improving your income, if only for mortgage application purposes. When you’re ready to buy a home, ask your mortgage broker about getting a mortgage pre-approval to lock in the best mortgage rate and gain certainty about how much you can afford.

Categories	Mortgages
Tags	mortgage mortgage rates mortgage stress test Personal Finance stress test