The Canadian mortgage stress test, explained

“It applies to everyone—you, me, first-time buyers and 10-time buyers,” says Maxine Crawford, a mortgage broker who serves the Greater Toronto Area (GTA) and elsewhere in Ontario. “That includes people who already own a home and need to refinance or renew their mortgage [with a different lender.]”

In spite of its broad application, many Canadians have never heard of the stress test or still don’t understand how it works. Here’s what you should know before you apply for your next home loan.

What is the mortgage stress test?

First off, it’s not a test like the kind you encounter in school. Rather, it’s a set of rules major banks must use to determine if you qualify for a mortgage. Because mortgage rates can fluctuate, as they have in recent months, the Canadian government has set a minimum qualifying rate to reduce the risk involved in mortgage lending. This helps to ensure you’ll still be able to afford your mortgage payments if interest rates increase beyond the rate originally stated in your contract. In other words, it’s not you but your finances that are put to the test.

How does the mortgage stress test work?

When you apply for a mortgage, the lender will offer you a contract interest rate based on current market interest rates (which follow changes in the economy), the characteristics of your mortgage and your credit history. (Here’s what influences five-year fixed and five-year variable mortgage rates, for example.) 

Under the stress test, however, your contract rate is not the rate the lender will use to determine your mortgage eligibility. Rather, it will make those calculations at a higher interest rate, to ensure you’ll be able to make your payments if or when rates go up. 

Watch: MoneySense – What is the mortgage stress test?

What is the mortgage qualifying rate in Canada? 

The mortgage qualifying rate refers to the rate at which you need to pass the stress test. As of June 1, 2021, the minimum qualifying rate for both uninsured mortgages (homes purchased with at least a 20% down payment, which includes all homes worth $1 million or more) and insured mortgages (homes purchased with less than a 20% down payment) is the higher of the following: 

• The rate offered by your lender plus 2%; or
• 5.25%

To put this into real terms: Let’s say you wanted to borrow $400,000, and your lender offered you a rate of 1.78%. You would have to prove you can afford a mortgage payment of about $2,385 per month (calculated at 5.25%), even though your actual monthly mortgage payment (at 1.78%) would be considerably lower (about $1,650).

Why was the mortgage stress test created?

The Canadian mortgage stress test first came into effect in 2016. At the time, it only applied to insured mortgages—loans for homes whose buyers had a down payment of less than 20%—which meant the applicants were required to get mortgage default insurance. With Canadians experiencing high levels of household debt, the goal was to create a financial buffer for buyers facing a greater risk of not being able to make their mortgage payments in the future.

“The stress test was introduced to add a margin of safety to ensure borrowers could make their payments if they faced a change in circumstances—such as if interest rates go up or their income changes,” says Crawford. 

In 2018, the stress test was expanded to include buyers with more than a 20% down payment (those with uninsured mortgages). Since then, all Canadian home buyers applying through a federally regulated lender—as well as those refinancing their current mortgage or switching to a new lender—have been required to pass the test.

Recent changes to the mortgage stress test

The Office of the Superintendent of Financial Institutions (OSFI), a federal government agency that acts as Canada’s banking watchdog, modified the stress test in June 2021. Previously, the stress test rate was set at either 2% above the contract rate that buyers negotiated with their lender, or at the posted Bank of Canada (BoC) five-year rate, whichever was higher. 

However, after the BoC slashed rates at the onset of the COVID-19 pandemic, there were concerns that its five-year benchmark rate was too low to adequately protect borrowers from defaulting on their mortgages in the future. The minimum qualifying rate was decoupled from the central bank’s rates, and instead changed to a set floor that will be reviewed annually. 

OSFI is scheduled to review the stress test rules in mid-December. However, it has the ability to review the rules at other times throughout the year, and it has warned it may take that step in 2022 as the Bank of Canada pursues a round of aggressive rate hikes.  

What does the stress test mean for borrowers?

The stress test reduces the size of mortgage that buyers can qualify for, says Crawford. So, unless you are able to come up with a bigger down payment to make up the difference, the test also lowers your maximum purchase price. 

For example, if there were no stress test at all, a borrower with an annual income of $125,000 and a minimum down payment could qualify to purchase a $750,000 home (assuming an interest rate of 2.60% and a 25-year amortization). But using the current stress test benchmark of 5.25%, the same borrower’s buying power drops to only $600,000, Crawford says. “As a result, the stress test often also impacts the type and/or location of the property that borrowers can purchase.” 

With the June 2021 change to the qualifying rate, OSFI estimates that the majority of borrowers saw their mortgage loan qualification amount go down somewhere between 2% and 4%. And since renewing mortgage holders need to “pass” the stress test if they switch lenders or want to borrow extra money against their home’s equity, some may be forced to renew with their existing lender instead of shopping around, says Crawford. 

The stress test at a time of rising interest rates

At the height of the pandemic, when fixed and variable rates fell into the 1% to 2% range, most borrowers faced a qualifying rate of 5.25%. 

But with the recent jumps in the benchmark rate, almost everyone who has to qualify based on the stress test is qualifying at a rate higher than 5.25%, notes Matt Imhoff, a mortgage agent with Mortgages.ca. For example, obtaining a variable rate of 4.7%—equal to the prime rate at the time of this writing—now requires qualifying at 6.7%. “You’d have to subtract pretty hard [from the prime rate] to get down to 5.25%,” says Imhoff. “So my opinion is, you really need a good reason to be getting a mortgage today.”

Denise Laframboise, from LaframboiseMortgage.ca in Brooklin, Ont., adds that home buyers who were pre-approved for a mortgage before the BoC’s most recent rate hike may need to revisit the maximum they can afford to spend on a home. The mortgage broker says clients are now qualifying for mortgages that are 10% to 15% smaller than what they could have been approved for prior to the July rate increase. And even if you’ve obtained a rate hold—confirmation that your rate will not change for a specified amount of time—you might still encounter challenges getting financing.

“Typically a ‘rate hold’ is a guarantee of rate under specific conditions and terms, not a guarantee of financing. The bank has not reviewed your documents as part of the ‘rate hold’ process,” says Laframboise. “So while the rate hold might protect you from an increased qualification rate, it could also expire or not apply to the home you purchase when you negotiate a live offer. I would always stay in touch with your mortgage broker or banker to get updated numbers as changes occur, just to err on the side of caution.” 

Is there any way to avoid the stress test?

No, there isn’t. Canada’s big banks are mandated to enforce these rules for all mortgage borrowers. And there’s no way to avoid the stress test if you’re getting an insured mortgage from any lender. 

For uninsured mortgages, however, lenders that are provincially rather than federally regulated—such as credit unions—can use a lower qualification rate than is mandated by the stress test. So, for example, they might allow a borrower with an excellent credit score to qualify at 3.25% instead of 5.25%. But the mortgage contract rate is likely to be significantly higher than the most competitive rates available. “Basically, you pay for the privilege of qualifying at a lower rate,” says Crawford.

Otherwise, borrowers looking to increase home affordability can work to lower their amount of other personal debt or get a co-signer to qualify for a larger mortgage.

How to calculate what you can afford with the mortgage stress test

Before speaking to a lender or broker, you can use online tools to calculate your mortgage affordability. The government of Canada’s mortgage qualifier tool, for example, will tell you whether you are likely to qualify for a certain mortgage amount, using the stress test rules.

Similarly, a mortgage affordability calculator looks at the maximum mortgage you can borrow based on the same qualifying criteria. 

More on mortgages:

• Why the mortgage stress test isn’t the villain it was made out to be
• How much mortgage can I afford?
• 7 smart strategies for first-time home buyers
• How much you need to earn to afford a home in Toronto and the GTA

About Justin Dallaire

Justin Dallaire is the senior editor at MoneySense.ca. He was previously the associate editor at Strategy magazine and has contributed to publications including The Walrus and TVO.org.

Linkedin Twitter