Taking the stress out of the mortgage stress test
Look no further than the recent interest rate hikes to understand why the mortgage stress test is so important. It protects the clients and the lenders if interest rates rise, and it’s in everyone’s best interest for the homeowner to afford their mortgage payments.
We know mortgage brokers are between a rock and a hard place—you want to help your clients get the home they want, but you also want to ensure they can truly afford it. So, how do you have that conversation with your clients? Be straightforward.
What exactly is the mortgage stress test?
The simple answer is that a mortgage stress test in Canada assesses whether a person applying for a new mortgage could still afford it if interest rates increase.
The stress test calculation is the higher of your interest rate plus 2% or the benchmark stress test rate of 5.25% (as of June 1, 2022), also referred to as the Bank of Canada’s qualifying rate. The Office of the Superintendent of Financial Institutions (OSFI) Guideline B-20 sets out expectations for residential mortgage underwriting in all federally-regulated financial institutions.
How does the stress test help your clients?
It comes down to this—it’s better to meet the stress test now than suffer the stress of losing their home later. Many Canadians carry debt, and as the cost of living rises, income is not always keeping pace.
All federally-regulated lenders use the B-20 stress test for new mortgages, alternative mortgages and mortgage renewals with a new lender (but are not applicable if they are renewing with their current lender).
B-20 stress test rules were designed to help guide your clients into a home they can afford. Simply put, the stress test ensures an additional 2% buffer to guard against inflation, and in 2022, we have seen this in real-life scenarios.
“Sound mortgage underwriting is critical for maintaining the stability of the financial system. This is especially true now when changing conditions such as potentially rising interest rates could make repaying mortgages more difficult in the future.”
– Peter Routledge, Superintendent, OSFI
How can you manage client expectations about mortgages during times of high inflation?
First, look at the numbers and advise your clients on their options for variable or fixed-rate mortgages.
- Spell out the payments now and show them what payments would be if interest rates rise. This should help them understand the value of the stress test.
- If you are looking at uninsured mortgages, you may be looking at a short-term mortgage of 1-3 years to get them into the housing market, considering these rates are typically higher. Depending on the amount of down payment, their amortization period could be 30 years or higher, which may decrease their monthly payments.
- Look at their finances and credit score to determine their GDS/TDS debt servicing ratios. From there, you will have a good idea of their price range and what a bank will offer for their mortgage.
Getting your clients into a new home
Buying a home is also an emotional decision. Homeownership is often worth some sacrifices, so it may take some outside-the-box thinking when it comes to finding what your clients need within the stress test parameters and higher interest rates.
Although mortgage stress test rules may be applied differently by provincially regulated funders, like credit unions or private lenders, you want to ensure that your client can successfully maintain their mortgage payments and lifestyle.
As a mortgage broker, here is a quick refresher on some valuable advice you can provide to your clients.
- Can they put together a larger down payment? This will reduce the mortgage amount.
- Would they consider living in a different neighbourhood? The same type of house in another community could save thousands of dollars.
- Are they stuck on having a specific type of home? Perhaps buying a smaller home for less money may allow the clients to pay down their mortgage quicker, as they can apply some of the savings they’ve earned by having a smaller mortgage to the principal of their mortgage.
- Are they already working with a realtor? A good realtor can help them find affordable options they may not have considered.