How to ace the mortgage stress test

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If the thought of studying—especially for something as stressful as buying a home—sends shivers down your spine, you’re not alone. Luckily, the mortgage stress test is one test you don’t need to stay up all night to cram for.

Though it may sound hard (and stressful), with a bit of preparation and expert advice from Jennifer Englehart, Financial Service Representative with OMISTA Credit Union, we can help you ‘pass’ the mortgage stress test with flying colours.

What is the stress test?

“People tend to make the mortgage stress test more complicated than it needs to be,” says Jennifer. “Financially speaking, think of it as a way to plan for the worst-case scenario—it’s a way to test your finances to make sure, if something happens, you’ll still be able to afford your mortgage.”

In other words, the mortgage stress test is a way to “test” your finances to make sure you don’t bite off more than you can chew when it comes to taking on the debt associated with a mortgage. Your lender will run the number as part of the discussion around applying for a mortgage.

All about rates

When it comes to applying for a mortgage, there are two rates to consider: the contracted rate and the stress test rate.

The Bank of Canada determines the stress test rate while your lender determines the contracted rate. The exact number for the contracted rate depends on your personal application, but things like your credit, net worth, job stability, income, and debt ratio are all factored into the calculation. Because everybody’s financial situation is unique, everybody will have a slightly different rate, but generally speaking, the contracted rate is always lower than the stress test rate.

The stress test is simply a way for your lender to make sure you can afford your mortgage payments. When you apply for a mortgage, your lender will make sure you can afford payments calculated at the stress test rate, not the contracted rate. This way, if rates go up over the course of your mortgage, you’ll have some financial wiggle room and won’t be put into a tough financial situation.

How to prepare

Like most situations, knowledge is power. The same is true when it comes to getting ready for your mortgage stress test.

“Start by paying down as much personal debt as possible and save as much money as you can for your down payment, legal fees, and closing costs,” says Jennifer.

The more information you have, the more prepared you’ll be.

Another way to prepare is to keep a detailed—and honest—budget for a few months. Knowing where you spend your money—and how much of it—will help you and your lender understand what you might be able to afford in terms of a mortgage. Having an accurate view of how you spend could also help you make decisions about where you might need to cut back and think differently to make things work.

It’s also important to think about your lifestyle, too. For instance, 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, you’ll need to make sure you’re budgeting for vacations in addition to your housing costs.

“I always like to talk to first time home buyers about their big picture goals,” says Jennifer. “Having those big conversations is really the best way to study/prepare for buying a home.”

Debt ratio

Debt ratio is one of the most important considerations when it comes to getting a mortgage. Essentially, debt ratio is how much you owe versus how much you make. On average, a debt ratio between 35–40% is considered comfortable. Your debt ratio is something your lender will determine based on your income, your debt, and your assets.

“The maximum debt ratio is 44%—that means your income is high enough to cover your existing debt and your new mortgage payment, utilities, and taxes,” says Jennifer. “But really, you should try to be under 40%.”

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, home repairs, or any other major expense that could come up.

Extra credit

For many first time home buyers, debt ratio might be a bit of a sticking point. This is especially true for young professionals and recent grads who might be carrying high student loan debt, but who have the potential to earn a decent salary. And that’s where a credit union can be helpful.

“We can look outside the box when it comes to your mortgage. We look at you as an individual, not just at the numbers,” says Jennifer. “Say you’re just starting out in your career as a young professional and you’re at your maximum debt ratio because of student loans. Credit unions can work with you to understand your situation and approve you for a mortgage, even if you’re at your maximum based on the knowledge that your income will increase over time.”

That’s not to suggest that credit unions are financially irresponsible or will offer you more mortgage than you’re comfortable paying. Quite the opposite, in fact. Because credit unions often know their members on a more personal basis, it means we 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. The experts at your local credit union are here to help.