The Canadian real estate market has been on a rollercoaster ride in recent years, with prices skyrocketing in many cities to a huge downturn of prices and skyrocketing interest rates. To ensure financial stability and protect borrowers from overextending themselves, the Canadian government implemented a stress test for mortgage applicants in 2018. Today we will explore what the stress test is and how it works.
What is the stress test?
The stress test is a financial requirement implemented by the Canadian government that requires mortgage applicants to demonstrate that they can afford higher interest rates than the one they are applying for. The goal of the stress test is to ensure that borrowers can still make their mortgage payments in the event of an increase in interest rates or a change in their financial situation.
How does the stress test work?
The stress test is applied to all borrowers applying for a mortgage, regardless of the size of their down payment. Borrowers must demonstrate that they can afford a hypothetical mortgage payment that is based on the higher of two scenarios: either the Bank of Canada's posted five-year mortgage rate or the borrower's contract rate plus two percentage points. Whichever rate is higher is the one that the borrower must qualify for.
For example, let's say that the Bank of Canada's posted five-year mortgage rate is 5%. A borrower with a contract rate of 3.5% plus two percentage points (or 5.5%) must demonstrate that they can afford a mortgage payment based on a 5.5% interest rate, even though their actual mortgage rate is only 3.5%. This ensures that the borrower can still afford their mortgage payments if interest rates rise.
What are the consequences of failing the stress test?
If a borrower fails the stress test, they may not be approved for a mortgage, or they may be approved for a lower amount than they originally applied for. The stress test can be particularly challenging for first-time homebuyers or those with lower incomes, as they may not be able to afford a higher mortgage payment.
However, it's worth noting that the stress test is designed to protect borrowers from overextending themselves financially. By demonstrating that they can afford a higher mortgage payment, borrowers are less likely to default on their mortgage if interest rates rise or their financial situation changes. If you have been paying attention to the market and all of the rate hikes over the past year, you will know that the interest rates have rapidly increased at a faster rate than we have seen in decades!
Did the government see this coming? We do not think so. The rates are now higher than folks were being stress tested for a couple of years ago. Did this save Canadians from overextending themselves?! Have we seen the fallout of rising interest rates?! We believe the impact of rapidly rising interest rates is not fully in effect yet especially since we had another increase this month!
In conclusion, the Canadian real estate market stress test is a financial requirement that all mortgage applicants must go through to ensure that they can afford their mortgage payments, even if interest rates rise or their financial situation changes. While the stress test can be challenging for some borrowers, it is ultimately designed to protect them from overextending themselves financially and ensure financial stability in the Canadian real estate market.
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