Mortgage stress test: What it is, how it works, and how to ace it

Applying for a mortgage can be a nerve-wracking process. There is a lot to consider: your budget, expenses that might arise if repairs are needed, and whether your job will change. On top of these factors is the looming thought of how interest rates may shift in the future, but there is a method to test yourself against this. That method is called the mortgage stress test.

So, what is this mysterious mortgage stress test, and why do financial institutions use it when deciding how much mortgage to lend you?

That is a great question, and we’re here to help answer it. Homeownership is a complex journey, and credit union experts are here to help you navigate it. A great place to start is ensuring you understand how the mortgage stress test will impact you and your future home.

The mortgage stress test shows what you can afford

A mortgage stress test is designed to make sure you don’t find yourself in a bad situation if interest rates change dramatically. It requires you to qualify for your mortgage based on a higher interest rate, which ensures you can still afford your mortgage payment if interest rates increase in the future.

To put it bluntly, the mortgage stress test is how a lender will “test” your finances to make sure you don’t bite off more than you can chew when you buy your home and take on the debt associated with its mortgage.

The stress test is hard—on purpose

When it comes to applying for a mortgage, there are two rates to consider: the contracted rate and the stress test rate. Wondering why you should care about the stress test rate? It’s a key factor in financial institutions (including credit unions) determining if you can afford their contracted rate.

How this works: the Bank of Canada determines the mortgage stress test rate, while your lender determines the contracted rate. The contracted rate you are given is determined by how personal variables like your credit, net worth, job stability, income, and debt ratio impact the calculation. Because everybody’s financial situation is unique, everybody will have a slightly different rate, but generally, the contracted rate is always lower than the stress test rate.

The stress test is simply a way for your lender to ensure you can always afford your mortgage payments. When you apply for a mortgage, lenders need to ensure you can afford payments calculated at the higher stress test rate. That shows them that if rates go up over the course of your mortgage, you’ll have the financial wiggle room needed to stay out of a tough financial situation.

How to prepare for the mortgage stress test

As in most situations, the more you know, the better prepared you’ll be. Keep a detailed budget (one that’s as honest as the advice we’d give you) for a few months. Knowing where and how much money you spend will help you and your lender understand what you will be able to afford in terms of a mortgage. 

Having an accurate view of your spending can also help you decide whether to cut your spending in other areas. You can also connect with a credit union expert and see how cutting costs can save your dollars, especially as you look at buying a house.

You can also evaluate your lifestyle. If always having a new car is important to you, you’ll need to factor that into your budget. Likewise, if travel is something you enjoy doing often, you’ll need to make sure you’re budgeting for vacations in addition to your housing costs.

How credit unions can help with your mortgage

When it comes to getting a mortgage that debt ratio and extra credit are two of the most important things to consider. 

Debt ratio is essentially how much you owe versus how much you make. Keeping your debt ratio lower means you’ll have more room in case you need to access some extra cash for things like buying a new vehicle, making home repairs, or any other major expense that may come up. And because credit unions often know their members on a more personal basis, it means they can work with you to find unique solutions you may not be able to find elsewhere.

While buying a home may seem like a huge step, with the right advice and expertise, it doesn’t have to be overwhelming. been there, and they can help you navigate homeownership, mortgages, and the stress test, too.