Q – We’ve been shopping for a new home, but we’ve heard some horror stories from friends about the mortgage market. Apparently there’s something called a “stress test” you have pass before you can qualify for a mortgage, even if you don’t have to be insured! If you don’t pass the stress test, you don’t get a mortgage. This is stressing us out even more. Can you explain what this is all about and what else I can do to make my mortgage borrowing a bit easier? – Glenda S., Whitby, Ont.
A – The so-called “stress test” for those seeking residential mortgages came into force on January 1 this year. It is a federal government-mandated requirement issued by the Office of the Superintendent of Financial Institutions, so there’s no escape. Anyone borrowing from a lender subject to federal regulation (and that includes just about every financial institution in Canada) will have to pass the OSFI Mortgage Stress Test in order to be approved for a mortgage. And note, this now applies to all borrowers, including those making down payments of 20 per cent or more, who typically don’t need mortgage insurance.
Applied to the loan application, the stress test will look at such things as how much you’ll be able to afford with your current debt-to-income ratio, and whether you’d be able to continue making payments if interest rates rise or you lose your job. But the kicker is that even if you qualify a mortgage at a current contracted rate today, you’d still have to qualify for a mortgage at an even higher rate, which is calculated as your current rate plus two percentage points, or the average posted five-yearyear bank rate, whichever is higher.
So if you have currently contracted for a standard bank-offered mortgage with a five-yearyear fixed rate of, say, 3.29 per cent, you’d still have to first pass the stress test to qualify for the same mortgage at a 5.29 per cent rate, or the five-yearyear posted bank rate, currently at 5.14 per cent, whichever is higher. The stress test has the effect of cutting your borrowing capacity substantially. If you don’t pass the stress test at the higher rates, you won’t qualify for the mortgage. Most at risk are those who have stretched their budgets to the limit in seeking the kind of house the want. For those in this position, the result is that you may be forced to revise your expectations and look for a lower-priced home.
There are a few other principles to keep in mind when wading into the mortgage market.
First off, make the biggest down payment you can. At the very least try to match or exceed the 20 per cent threshold beyond which mortgage insurance isn’t necessary. You’re more likely to pass the new stress test rules. Mortgages for more than 80 per cent of the purchase price must be insured, and the insurance premium is added to the monthly payment.
Next, always negotiate for the lowest interest rate possible. It’s even possible to bargain with the big banks if you are a good risk and have a sizable down payment. Consider variable rate mortgages, which typically have posted rates one half percentage point lower than fixed-rate mortgages, only if you have a monthly cash-flow cushion to withstand a sudden rate increase.
Try to reduce the amortization period as much as possible. Yes, the longer the amortization, the lower your monthly payments, but the higher the total interest paid will be. Cut your amortization, even it’s only by a year to begin with. And keep reducing it at the end of every term when it comes time to renew, while maintaining or increasing your monthly payment.
Take advantage of prepayment privileges. If you have the ability to pay off a lump sum of your principal amount without penalty every year, do so! It reduces your principal amount immediately, and your interest costs shrink dramatically over time. Also, make weekly or bi-weekly payments instead of monthly payments. This can also add up to big interest savings over time.
The mortgage market can get complicated, and the new stress test rules have added another layer of anxiety to the mix. To avoid surprises, disappointments, and additional pressure at the lender’s office, check with your financial advisor before you sign on the dotted line. They’ll be able to give you a precise idea of what you can afford, whether you’ll pass the stress test, and how much you’ll be able to borrow.
— Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. She is also listed as a MoneySense Approved Financial Advisor. Contact her directly by phone at 416-828-7159, or by email at email@example.com for a confidential planning consultation.