The mortgage stress test can be a challenging hurdle for homebuyers, but it’s an unavoidable reality for anyone looking to purchase a home in Brampton, Toronto, or the Greater Toronto Area.
Introduced by OSFI and the Department of Finance to ensure borrowers can handle their mortgage payments in the event of rising rates, the stress test continues to be a key step in the home-buying process even now that we are in a declining rate environment. Understanding and preparing for the stress test can make the difference between securing your dream home and facing rejection. Here are some tips to help you navigate this important hurdle.
1. Understand the Mortgage Stress Test
The mortgage stress test requires all federally regulated lenders to evaluate your ability to make mortgage payments at a higher interest rate than your contract rate. The stress test applies to new mortgage applications, switching an uninsured mortgage i.e. more than 20% equity, and for mortgage refinances. If your mortgage is insured through CMHC, Sagen, or Canada Guaranty, you can switch your mortgage for a better rate without going through this hurdle and qualify at your contract rate. It also doesn’t apply if you renew with your existing lender.
The stress test rate is 2% above your contract rate, or the Bank of Canada’s five-year benchmark rate currently 5.25%, whichever is higher. This measure ensures you can afford your mortgage if rates increase. Your payments are based on your contract rate, but you must qualify at this higher rate.
For example, if you took a 5-year fixed mortgage at 4.69%, you would be stress tested at 6.69% because it is higher than 5.25%. If you wanted to go variable at 5.65% and look to lower your payments after each Bank of Canada rate cut, you would be stress-tested at 7.65%. While it’s possible that taking variable may be the better option over time as we enter a rate-cutting cycle, some may find it easier to qualify at 6.69% vs 7.65%. As rates decline, the stress test becomes easier.
2. Boost Your Credit Score
A higher credit score improves your chances of mortgage approval and can help you secure a lower interest rate, making it easier to pass the stress test. Here are some steps to improve your credit score:
- Consistently pay all your bills on time.
- Keep your credit card utilization low, don’t reach your limit but keep your balance to no more than 30% of your limit if possible.
- The longer your credit history the better. Don’t close accounts without getting advice, especially ones you’ve had the longest.
- Avoid applying for new credit before your mortgage application.
- Check your credit report for errors and dispute any inaccuracies.
3. Increase Your Down Payment
A larger down payment reduces the amount you need to borrow, improving your affordability under the stress test. If you can achieve a 20% downpayment, you will avoid mortgage insurance and strengthen your application. Consider saving aggressively using the First Home Savings Account, access your RRSP funds through the Home Buyers’ Plan, or explore a gifted downpayment.
4. Reduce Your Debt
Lenders assess your Gross Debt Service (GDS) and Total Debt Service (TDS) ratios to determine your ability to manage monthly payments. Lowering these ratios improves your chances of passing the stress test. Strategies to reduce your GDS and TDS ratios include:
- Paying down high-interest debt, such as credit cards and personal loans.
- Avoiding new debt before applying for a mortgage.
5. Take a Longer Amortization
Taking a longer amortization period, such as 30 years, for an uninsured mortgage (i.e., more than 20% down) can help you with the stress test by lowering your monthly payments. Additionally, a longer amortization period can improve your debt servicing ratios. However, it’s essential to consider the trade-offs, such as paying more interest over the life of your mortgage.
6. Get a Cosigner
A cosigner agrees to take on the responsibility of the mortgage along with you. This can be a parent, relative, or close friend with a strong
credit history and stable income. A cosigner with a strong credit score can improve your overall credit profile, making you a more attractive candidate to lenders. Adding the cosigner’s income can significantly boost the total income of your application, improving your debt servicing ratios. Lenders are also more confident in your ability to make mortgage payments when there is another person legally responsible for the loan.
7. Increase Your Income
Increasing your income if you can is something to consider if you want to open the door to homeownership. Some ways to boost your income:
- Ask for a raise or promotion and take advantage of overtime opportunities
- Take a second job
- Freelancing or consulting
- Start a side business
- Invest in education or training for better job opportunities and higher pay.
- Participate in the gig economy by driving for ride-sharing services, delivering food, or freelancing through platforms like Fiverr.
8. Choose a More Affordable Home
Adjusting your expectations and choosing a more affordable home can significantly enhance your ability to pass the stress test. This might mean considering smaller properties, different neighborhoods, or homes needing renovation.
9. Consider Alternative Lenders
While traditional banks are federally regulated and adhere strictly to the stress test, alternative lenders such as credit unions, private lenders, and certain national and regional lenders often have more flexible requirements. These lenders are not subject to the same federal regulations, allowing them to offer more lenient qualification criteria.
- Flexibility in Criteria: Alternative lenders may consider a broader range of income sources, including self-employment and non-traditional income, which can be advantageous for those who might not qualify with a traditional bank.
- Faster Approval Process: These lenders often have quicker approval processes, beneficial in a competitive housing market where timing is crucial.
- Potentially Lower Stress Test Requirements: Since alternative lenders may not follow the same stringent stress test rules as banks, they can provide more attainable qualification standards, increasing your chances of approval./li>
However, they may charge higher interest rates and fees and have shorter loan terms. By carefully considering the pros and cons of alternative lenders and leveraging Rakhi Madan’s expertise and lender network, you can make a well-informed decision that enhances your ability to pass the mortgage stress test and secure your dream home.
10. Get a Pre-Approval
A mortgage pre-approval gives you a clear picture of what you can afford and strengthens your ability to put in an offer when house hunting. A pre-approval involves a preliminary assessment of your financial situation, including the stress test, providing a realistic budget range, and increasing your confidence in the buying process.
Work with Brampton’s Best Mortgage Broker, Rakhi Madan
Rakhi Madan is Brampton’s best and most experienced mortgage broker, known for her dedication to her clients’ best interests. With over 400 five-star Google reviews, Rakhi takes the time to understand your unique situation in-depth, ensuring custom solutions that meet your specific needs. You’ll appreciate Rakhi’s calm demeanor as she guides you through the challenges of becoming a homeowner, buying your next home, and renewing, or refinancing your mortgage. You can trust Rakhi’s expertise to navigate the mortgage stress test and confidently achieve your homeownership dreams.
