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 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 East Coast Credit Union Branch Manager, Elaine Robertson, we can help you ‘pass’ the mortgage stress test with flying colours.

What is the stress test?

A stress test helps make sure you don’t find yourself in a bad situation if rates change dramatically. “It means that you have to qualify for your mortgage based on a higher interest rate,” says Elaine. “It’s used to ensure homebuyers can afford their mortgage payment in the event of an interest increase in the future.”

In other words, the mortgage stress test is a way for the lender 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.

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, 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 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.

As of June 1, 2021, the mortgage stress test rate changed from 4.79 to 5.25 per cent.

What does the rate change mean for prospective homebuyers in Atlantic Canada?

Rate changes have been effective in Canada since October 2016 and are intended to protect both borrowers and lenders in the event of rate increases. However, this change is significant.

“It’s increasing not just from 4.79 to 5.25 per cent, but it’s also going to increase by 2 per cent above the purchasers’ contract rate,” says Elaine.

Due to this change, homebuyers can expect to see their purchasing power decrease by about 4.5 per cent. “If you’re in the market for a home and you haven’t found the right one yet or you haven’t signed a purchase and sale agreement and you’ve got less than a 20 per cent down payment, then this will impact you,” says Elaine.

How to prepare for the Mortgage Stress Test

Like in most situations, knowledge is power. The same is true when it comes to getting ready for your mortgage stress test. 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, will help you and your lender understand what you will 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 evaluate your lifestyle. 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.

Incentive options for new homebuyers

If you’re a first-time homebuyer, there are incentives that can help you. “There is an option available through the government of Canada and CHMC for new homebuyers called the New Homebuyers Incentive. This reduces your mortgage value by about 5 per cent and 10 per cent if you’re doing new construction,” says Elaine. “It’s an equity sharing model, so you don’t need to pay it back in the form of a loan, but you’re sharing the equity with the government. So, at the time you’re selling your home you will need to pay back that 5 per cent to the government in that model.”

Some credit unions provide a Cash Back option, where you can get 7 per cent of your mortgage value back in the form of cash. Like the New Homebuyers Incentive, it is not a loan. “You can use that to improve your purchasing power, put money toward renovations as opposed to increasing your mortgage value, or improve your financial picture and put it toward other debts and create cash flow.”

How credit unions can help

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

Essentially, debt ratio is 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, home repairs, or any other major expense that could come up.

This is where a credit union can be helpful. 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.