For homebuyers and owners in Brampton, Toronto and the GTA, the last two Bank of Canada rate announcements have been quite the wake-up call after two years of historically low pandemic rates. We knew it was coming and we prepare the best we can, but it always does take time to adjust. More hikes likely to come, with some economists saying its possible the Bank of Canada will announce another 50-bps hike to their overnight rate on June 1. Not the most favourable news for variable mortgage holders since their rate fluctuates in conjunction with the overnight rate. If you have a variable mortgage, remember why variable was the right choice in the first place, to pay less interest over the long run and not be locked into a mortgage with a large penalty to get out.
Fixed rates have also been increasing as they respond to rising bond yields. Where it goes from here no one really knows for sure. The main question is – how long will inflation be entrenched in our lives? Rising rates are used to slow the economy, which eventually leads bond yields/fixed rate mortgages and the Bank of Canada overnight rate lower.
How does rising rates affect the stress test and does it matter?
The impact of rising rates on mortgage payments is obvious, but we often forget that there is also an impact on the stress test used for mortgage qualifying, often referred to as the qualifying rate.
All federally regulated lenders are required to implement this test. It was introduced by the Department of Finance (insured mortgages) and OSFI (uninsured mortgages) to make sure all new mortgages were evaluated and approved at a rate higher than what is offered by your lender. It is intentionally set higher and reduces the amount of mortgage you qualify for. The goal is to ensure your mortgage payments not only fit in your budget now, but also in a future of rising rates. Your actual payments are of course based on the rate negotiated with your lender.
After years of being different, the stress test is now the same for both insured and uninsured mortgages. New mortgages are stress tested at the higher of –
- The government mandated minimum qualifying rate, which is currently 5.25%, or
- Your mortgage contract interest rate + 2%.
This applies to all new homebuyers. If you already have a mortgage, you’ll need to pass this stress test if you:
- refinance your mortgage – refinancing means that you replace your current mortgage with a new one so you can access some of your accumulated equity to consolidate debt, complete renovations, help a child buy a home, buy a second property or for any large expense or investment (20% equity is required to refinance and fees to break your mortgage may apply, get in touch for more information and a cost benefit analysis)
- switch to a new lender for a lower rate or better terms, or
- take out a home equity line of credit
At a 2.3% variable rate, the stress test applied by the lender for qualifying purposes would be the minimum of 5.25% since 2.3% plus 2% is less than 5.25%.
At a 4.09% fixed rate, you would be stress tested at a much higher 6.09% (4.09% + 2% is greater than the minimum 5.25%), which will reduce your buying power. Having a qualifying rate above the minimum 5.25% is quite a notable change from the last two years.
If the stress test is affecting your ability to get the mortgage you want, here are 5 options you can consider:
- Variable rates have a qualifying advantage right now, which will encourage some to take variable even if they prefer the stability of fixed rates. There is a workaround you could consider if fixed is your preference – go for a variable rate to qualify and then lock into a fixed rate once your mortgage closes. Variables allow you to lock in at anytime without a stress test. Just check beforehand what that fixed rate will be at conversion so there are no surprises, and you are comfortable with the rate.
- If you have 20% equity and qualify for a conventional mortgage, another workaround is to look at Credit Unions that can qualify you without using the government’s stress test because they are not federally regulated. There is a rate premium but when it comes to qualifying, you are further ahead. This doesn’t apply to insured mortgages (under 20% equity) because a mortgage insurer becomes involved.
You can also have a 30-year amortization with a conventional mortgage which further improves affordability should you need it, although again there is a rate premium. What I like about this strategy is that it gives you nice flexibility. You can minimize your mortgage payments and free up cash flow for other uses or life situations. Or you can keep your payments at a shorter amortization and only use this flexibility if the need arises.
- B and private lenders are another option although with a much a much higher rate.
- If the stress test is just too much of a hurdle, perhaps you can look at getting a gifted downpayment from an immediate family member. This can improve your qualifying and may allow you to get a conventional mortgage and a 30-year amortization.
- Having one or both of your parents co-sign your mortgage is another strategy that can improve your ability to qualify for a mortgage, especially if they are in a strong financial position.
What about renewals and switches?
If you are renewing or want to switch your mortgage, yes there are stress test implications. You aren’t stress tested to renew your mortgage with your existing lender. However, if you want to shop around for a better deal at another lender, you’ll come up against the qualifying rate. This can limit your ability to achieve a better rate at renewal and lock you in with your current lender. Shopping around for better rates is therefore not available for all homeowners, which causes you to wonder why when affordability is such a hot topic these days.
Is there a bottom line?
Yes, there always is! When qualifying gets tougher and mortgage rules are complex and confusing, that’s when you need advice from an experienced and trusted mortgage advisor, someone who has seen it all and has access to lending options that can meet a myriad of needs. I am proud of the education I provide my clients. I want them to make the most informed decisions possible so they can save money and achieve their dream of homeownership and future financial security. I’m here to help homeowners and buyers in Brampton, Toronto and the GTA get the best mortgage deal. Please contact me at anytime!
