Understanding the mortgage stress test

When looking to get into the housing market, you’ll naturally focus your attention on several considerations. A down payment? You’ve been squirrelling away your savings for years. A solid credit score? Your stellar financial habits have paid off here. A potential home? You have your eye on a few.

Yet, one factor isn’t always top of mind: how you would manage if mortgage rates rose. That’s where a mortgage stress test comes in. We recently sat down with our Member Advisor Centre team to learn more about this financial assessment.

Simply put, a mortgage stress test helps lenders determine whether a borrower can afford their mortgage payments if interest rates were to increase. This means that they must qualify for a higher interest rate than the one they are being offered.

The stress test can sound daunting, but it’s designed to help homebuyers.

Borrowers sometimes overlook certain payments when determining how much they can afford—like hefty heating bills during the winter. The stress test gives them a clear picture of their home ownership costs, allowing them to see if they can afford these payments if rates increase. That’s the biggest advantage: it protects them by ensuring they don’t take on more debt than they can handle.

In Canada, the stress test is required for anyone who is being considered for a mortgage at a federally regulated financial institution. This could be for the purchase of a new home, to increase cash flow by refinancing an existing mortgage or to transfer a mortgage to a different lender.

A stress test ultimately looks at whether you could afford your mortgage payments if interest rates rise to what’s called a qualifying rate.

To do this, members must prove that they can meet the Bank of Canada’s five-year benchmark rate (5.25%), or the rate offered by their lender plus 2.00%—whichever one is higher. So, let’s say that your lender’s rate is 4.75%. In this case, the higher 6.75% qualifying rate is used (since it’s more than the 5.25% benchmark rate).

Once the qualifying rate is determined, the stress test mortgage payment is calculated. With this calculated payment, lenders will look at two metrics: the Gross Debt Service ratio (the percentage of monthly household income that covers housing costs, such as mortgage payments and property taxes) and the Total Debt Service ratio (the percentage of income needed to cover debt, like car payments and student loans). This will show whether your income and debt would still allow you to make higher mortgage payments.