What home buyers should know about the Canadian mortgage stress test

The rules of the stress test have changed since they were first introduced in 2016, which can add to the confusion. But, make no mistake, the stress test impacts anyone applying for a mortgage from one of the major banks. And while provincially regulated lenders have more flexibility when it comes to mortgage approvals, many still use the test to evaluate customers’ financial risk.

“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.”

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. Essentially, the stress test ensures you’ll still be able to afford your mortgage payments if interest rates increase. In other words, it’s your finances that are put to the test.

Why was the mortgage stress test created?

Canada’s mortgage stress test first came into effect in 2016. At the time, it only applied to insured mortgages—loans in which the borrowers 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 mortgages or switching to a new lender—have needed to pass the test.

How does the mortgage stress test work?

When you apply for a mortgage, the bank will offer you a contract interest rate based on the current market interest rates. These rates are based on different economic indicators, such as the Bank of Canada’s benchmark interest rate. (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 considerably 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 (with at least 20% down payment) and insured mortgages (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 is offering 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 (at about $1,650).

Mortgage stress test changes

Prior to June 2021, the stress test rate was set at either 2% above the contract rate you negotiated with your lender, or the posted Bank of Canada five-year rate, whichever was higher. When the Bank of Canada 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 should there be a spike in rates once the economy recovered post-pandemic. 

As a result, the Office of the Superintendent of Financial Institutions (OSFI), a federal government agency that acts as Canada’s banking watchdog, decided to modify the stress test in 2021. The minimum qualifying rate was decoupled from the central bank’s rates, and instead changed to a set floor that will be reviewed annually. 

How does the bank determine what I can afford?

Of course, the mortgage stress test isn’t the only factor that goes into lenders’ mortgage calculations. To determine if and how much you can afford to borrow, they will also look at your existing debt load and your credit score. These factors, combined with the stress test, limit the amount you can borrow for your mortgage. 

There are two main figures banks use in their calculations. 

The first is the gross debt service ratio (GDS), which is the percentage of the borrower’s pre-tax income that will cover housing costs, including mortgage, heat and property taxes. The Financial Consumer Agency of Canada (FCAC) says your GDS should be no more than 32%, while the Canada Mortgage and Housing Corporation (CMHC) uses the limit of 39%. 

Then there’s total debt service ratio (TDS), which is any outstanding personal debt (including mortgage, car loans, credit card debt, lines of credit, etc.) and should be no more than 40% of pre-tax income, according to FCAC. The limit is 44% according to CMHC.

Let’s go back to our $400,000 mortgage example above, which showed us you would have to be able to afford mortgage payments of $2,385 per month under the stress test rules, assuming the offered rate is 1.78%. 

If heating and property taxes brought your total monthly housing costs to $3,000, you’d need a pre-tax monthly income of at least $9,375 (or $112,500 annually) to have a GDS of 32% or less. Similarly, based on that income, your total debt load could not exceed $3,750 per month (including your mortgage payment) to have a TDS of 40% or less in this scenario.

Can I use a mortgage stress test calculator?

Before speaking to a lender or broker, there are many online tools you can use 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. 

What does the stress test mean for borrowers?

The stress test reduces the size of mortgage that buyers will qualify for by about 20%, says Crawford. So, unless you are able to come up with a bigger down payment than before, the test also lowers your maximum purchase price. 

For example, if there was no stress test at all, a borrower with an annual income of $125,000 and 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, she says.

“As a result, the stress test often also impacts the type and/or location of the property that borrowers can purchase,” says Crawford. 

What’s the incremental effect of the most recent change to the stress test? The change raised the qualifying rate to a minimum of 5.25%, from the previous benchmark rate of 4.79%. And OSFI estimates that the majority of borrowers will see their mortgage loan qualification amount go down somewhere between 2% and 4%.

Renewing mortgage holders need to “pass” the stress test if they switch lenders or want to borrow extra money against their home’s equity. That may force them to renew with their existing lender instead of shopping around. And it could prevent them from accessing low-cost debt to finance home renovations or other expenses, says Crawford.

Is there any way to avoid the stress test?

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 excellent credit to qualify at 3.25% (instead of 5.25%). But the mortgage contract rate would also be set at 3.25%, which is significantly higher than today’s competitive rates. “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 debt or get a co-signer to qualify for a larger mortgage.

This article was originally published on March 9, 2020. It was last updated on March 25, 2022.

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