In life, it’s always considered wise to plan ahead and to try to mitigate any potential problems before they arise.
That’s why it’s smart to undertake a mortgage stress test, in case your mortgage payments are dramatically increased due to rising interest rates. It may also be helpful in the case that you lose your job and can’t meet your repayments.
What is a stress test?
A definition of a mortgage stress test is: a way of determining exactly how much you can afford to repay for your mortgage repayments if interest rates fluctuate (as they do) and/or if your income is reduced or you lose your job.
Currently, all Canadian home buyers seeking mortgages are now legally required to undertake a mortgage stress test to ensure that they can still make their payments at a rate that’s higher than they currently pay.
This means knowing that you can still afford to pay your mortgage if interest rates increase is crucial — and this knowledge may affect the price of the home you decide to buy.
When you apply for a mortgage, your bank needs to be sure that you’ll be able to pay back your mortgage (even if your mortgage rate rises during the mortgage term).
To do this, your ability to make your payments will be checked based on The Bank of Canada’s qualifying rate. This rate is based on the mode average of posted 5-year fixed rates from Canada’s big banks — and it is currently at 4.79%.
As such, your income needs to be high enough (and your existing debt low enough) to be able to pay down your mortgage at a higher rate. Generally, this will result in you being able to borrow a smaller amount of money.
In April 2020, The Department of Finance announced an update on how the rate was to be calculated. However, due to the COVID-19 pandemic, its implementation has been delayed. The new stress test mortgage qualifying rate would have been set at the median (not the average) 5-year fixed rate for applications received by CMHC in the preceding week.
This adjustment would have meant that the way the mortgage stress test was calculated for both insured mortgages and uninsured mortgages was very similar. Uninsured mortgages were already stress-tested at 2% higher than the rate of insured mortgages.
What a stress test means for borrowers
The COVID-19 crisis has seen mortgage rates drop to their lowest levels in decades, as the Bank of Canada has attempted to stimulate lending to restart the economy.
As the economy recovers, an increase of two to three percentage points on mortgage rates is quite likely — although it’s difficult to predict exactly when such interest rates are likely to rise again.
If interest rates do increase and you have a variable-rate mortgage, such increases will immediately affect your mortgage payments. If you have a fixed-rate mortgage, you’ll keep your current rate for the duration of your mortgage term — however, could be faced with an increase once your current mortgage term expires or comes up for renewal.
As an example, if you buy a home with a five-year fixed-rate mortgage of $375,000 at 2.89%, monthly mortgage payments will be around $1,752. In the event that mortgage rates increase to 5.34% once the initial five-year term ends, monthly payments will increase by around $500.
Just to be sure, why not input your own details into our mortgage calculator and see what your repayments might be?
If you feel you won’t be able to afford such increased payments, you may need to consider some options. For example, do you defer the purchase of your home and wait until you have a larger down-payment? Or do you go for a lower mortgage (and hence a cheaper property) to start with?
In any event, it’s a great idea to speak with your mortgage broker to help you determine your best course of action.
Contact Axiom Mortgage Solutions Today
At Axiom Mortgage Solutions, we have many years’ experience in arranging mortgages. To learn more about how we can help, get in touch with us today. Give us a call to make an appointment to discuss your mortgage-based needs!