TL;DR: the Stress Test is calculation used to see if you can probably still afford your home when your mortgage renews at the end of the Term. An interest rate that is higher than the rate you get, is used to calculate a theoretical mortgage payment at that higher rate. This higher payment amount is then used in calculating your debt servicing ratios to determine whether or not you qualify for a given mortgage amount. The idea is to make sure you can afford your mortgage if/when interest rates rise to what were historically considered 'normal' levels.

Why is this a thing?

Welp. Basically, the feds observed that Canadians were borrowing money at record levels, saw that home prices were unaffordable for many, and felt that the two were likely related. The stress test was an attempt to stop us from borrowing so much money, and hopefully at the same time help cool off housing prices. This would be done by "testing" up front whether our household budgets could handle the "stress" of higher mortgage payments down the road.

High-ratio mortgages

Beginning in October 2017, the federal government brought in new rules for anyone with a high-ratio / (i.e. lower than 20% down payment) mortgage. 

The new rule requires that all default insured mortgages must be qualified using a qualifying interest rate. The qualifying rate, or the Bank of Canada's Conventional mortgage - 5-year interest rate, is a mode average of the Big Banks' posted 5 year fixed mortgage rate. Roughly speaking, the qualifying rate has been about 2% higher than the typical 5 year fixed rate people actually end up paying.

Conventional mortgages

A conventional mortgage is one where the borrower has a 20%+ down payment (or already has 20% equity in the property). Starting January 2018, the stress test was expanded to include these types of mortgages, along with a new rule!

New rule!

Along with expanding the stress test to include conventional mortgages, the new rule says that if you are applying for a conventional mortgage, you have to use either the qualifying rate, or the contract rate (the actual rate you pay) + 2%, whichever is higher. For anyone whose interest rate was less than 2% lower than the qualifying rate, the stress test rate is now even higher.

Example

If your rate was 3.19% and the qualifying rate was 5.19%, the 5.19% rate is what would be used in the calculations.

If your rate was 4.19% (perhaps for a rental property, subprime loan, second mortgage), then the qualifying rate would be 4.19% + 2.00% = 6.19%, since the 'contract rate + 2%' calculation is higher than the 5.19%.

How does it affect me?

In the 2 years it has been in effect, our experience has been mixed. It is not often that a borrower has to majorly change their price range, and rare that a borrower is prevented outright from buying.

Generally speaking, it reduces buying power by about 20%. It will affect people who carry some debt, more than it will affect people with less debt. 

According to CMHC, in 2019, approximately 60% of home buyers borrowed right up to their maximum. Our experience hasn't been quite the same. We find most people are not borrowing right up to their maximum affordability. Often, even if they have some debt they are carrying, it isn't affecting the price range they are looking in. What we've seen is that most of our clients' household budgets keep their price range within what they qualify for under the stress test.

For some folks, whose needs or desires are for a larger home, and who may also be carrying a larger debt load, the stress test can and does impact how much they qualify for. This might have a negative lifestyle effect - if you need 4 bedrooms but the price range you qualify for only allows for 3, that's clearly not ideal.

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