Beat the stress test
Homebuyers may be surprised that having a slightly larger down payment may not make a big difference
Are you feeling stressed by the prospect of a mortgage stress test?
Qualifying for a mortgage has become tougher in the last year-and-a-half, whether you’re buying your first home or refinancing your current abode. Canada’s newest stress test was introduced in late 2017 for buyers with down payments less than 20 per cent and which automatically require mortgage default insurance. (The minimum mortgage down payment allowed in Canada is 5 per cent.)
“You have to qualify for a mortgage at a rate that’s 2 per cent higher than the (bank’s) contracted rate, or at the Bank of Canada five-year benchmark rate — whatever is higher,” says mortgage agent Hannah Stojanovski, of Dominion Lending Centres Altra Inc., in Ajax.
Since January 1, 2018, all homebuyers seeking a new mortgage are subject to a stress test if they are dealing with federally regulated lenders such as major banks, even if they have 20 per cent or more down. It also applies to homeowners renewing a mortgage with a new lender.
Other rules kicked in late last year:
insured mortgages could no longer be refinanced, buyers could not get mortgage default insurance for mortgages amortized for longer than 25 years or for homes valued at more than $1 million. Required down payments for homes priced at $1 million or more went from 5 per cent to 20 per cent.
The changes reduce homebuyers’ power, and Stojanovski gives the example of one of her clients: The woman earns $50,000 a year and can qualify for a $270,000 mortgage with 5 per cent down payment and no stress test. With the stress test, her buying power is reduced by 15 per cent and she qualifies for just $230,000 — a small mortgage in the GTA’s hot and pricey housing market.
Stojanovski says this pushes some buyers to less expensive markets, such as Oshawa, where homes are among the most affordable in the GTA. She says another potential trend is nonrelated people, such as two professionals, buying a home together.
Under the current mortgage rules, Stojanovski says homebuyers may be surprised that having a slightly larger down payment may not make a big difference. “The bank of Mom and Dad isn’t as much of an influencing factor anymore if they are giving a child some money toward a down payment,” she says. “Now, it’s more about income and a bit more down doesn’t make much difference.”
She says working overtime or earning bonuses carries weight with some lenders. Some, though not big banks, may accept baby bonus payments as income if one spouse works and the other stays home with the kids.
Stojanovski says the stress test may come as a shock to some homeowners who simply want to renew a mortgage. Shopping for the best rate with new lenders will subject you to the stress test.
“So, if you stay with your current bank for a renewal, you are off the hook for the stress test,” Stojoanovski says. “A lot of homeowners think because they have more equity in their home, it’s easier for them to get approved, when it’s actually tougher (because of the stress test).” What are your options if you’re worried about passing the test?
Stojanovski says credit unions are a good option. They are provincially regulated — but not federally — so aren’t required to impose the stress test. The borrowing rate, though, may be higher than that of a major bank.
For small-business owners who operate partially in cash or who work on contract, and homebuyers who have had a onetime bankruptcy and need to improve their credit, alternative lenders may be the answer, says Stojanovski. These lenders can be accessed through a mortgage broker and will take on clients most big lenders will not, but they usually charge higher interest rates and a lender fee.
With stiffer mortgage rules, Stojanovski advises planning a home purchase six to12 months ahead with a mortgage pre-approval that will let you know what you qualify for. Can you qualify? Let’s say you want to buy a $375,000 condo and have 20 per cent — $75,000 — as a down payment.
You’ll need a mortgage of $300,000. If a major bank, for example, is offering a five-year, fixed-rate mortgage of 3.99 per cent, without the stress test your payments for a 25-year amortization would be $1,576.45. But with the stress test, you’ll have to qualify 2 per cent higher, or at 5.99 per cent — monthly payments of $1,917.64.
One of the calculations lenders use is your Gross Debit Service ratio. As well as the stresstested payment, banks look at the monthly cost of property taxes and half of your condo fees and heating costs, add those sums up and divide by your gross monthly income. If the ratio is about 30 to 32 per cent, you will likely be approved.
However, lenders also want to know your Total Debt Service ratio. It’s a look at how much of your income goes to paying off credit cards, car loans, lines of credit and any other debt. Those debt payments should total up to 42 per cent (preferably less) of your pre-tax pay for you to qualify for a mortgage.