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Buying a home is the largest purchase most Canadians will make – and as of mid-2022 it became even more expensive, with rising interest rates driving up the cost of borrowing. Canada’s mortgage stress test has played a large role in that as well, by requiring buyers to prove they can manage rates well above what lenders are offering. Here’s a primer on how the stress test works, with insights from personal finance and mortgage experts.

What is Canada’s mortgage stress test?

The mortgage stress test is a financial calculation meant to ensure you can still qualify for your mortgage if interest rates rise.

The federal government introduced the stress test in 2016 for mortgage holders who were making a down payment of between 5 and 19 per cent and were required to purchase mortgage default insurance. In 2018, the Office of the Superintendent of Financial Institutions, or OSFI, the government agency that regulates federally incorporated lenders, expanded the stress test to buyers who make a down payment of at least 20 per cent and are uninsured. In essence, all insured mortgage holders and uninsured mortgage holders who get their mortgage with an OSFI-regulated lender must pass the test.

The current stress test rules, which came into effect on June 1, 2021, require borrowers to prove they can handle either the minimum qualifying mortgage rate of 5.25 per cent, or their contract rate plus two percentage points, whichever is higher.

Why was the stress test introduced?

With house prices soaring in 2016-17, the stress test was meant to give insured buyers more breathing room if the low interest rates they were borrowing at began to rise. “We know interest rates go up … and putting a buffer in place made sure Canadians could make their payments if they faced challenging circumstances,” says Angela Calla, a mortgage broker based in Port Coquitlam, B.C.

The test was also aimed at cooling Canada’s housing market. That year the average price for all housing types nationally had increased 10.7 per cent from the previous year, reaching a record high.

OSFI extended the stress test to uninsured buyers two years later out of concerns around high household indebtedness, and to guard against a wave of foreclosures if homebuyers struggled to pay their mortgages.

The stress test was also, in part, a lesson learned from the 2008 global financial crisis, Globe and Mail columnist Tim Kiladze wrote in June. Mortgages are the largest assets on the balance sheets of banks and other lenders, and a wave of defaults can ripple out to the broader financial sector.

OSFI’s move was received with “palpable and widespread” fury from the real estate industry, as the housing market was starting to cool at the time. It also sparked concerns that it could send borrowers into the unregulated lending market. It still has its detractors today. But, Mr. Kiladze argued, with inflation now at multidecade highs and the Bank of Canada hiking interest rates rapidly to wrestle it under control, the stress test is proving its value.

“If Canada still had the mortgage rules that existed when the housing market took off a decade ago, we would have every reason to be terrified now,” he wrote. “But we don’t, because, even in the face of serious backlash, regulators … prioritized controlling systemic risk.” (Data from the Canada Mortgage and Housing Corp. showed mortgage delinquency rates in Canada have remained below 1 per cent for the past 10 years, and since 2018 have never risen above 0.3 per cent.)

How does the stress test affect homebuyers?

Initially, OSFI set the stress test rate at the higher of two percentage points above a buyer’s contract rate or the posted Bank of Canada five-year rate. But after the Bank of Canada drastically cut interest rates during the pandemic, OSFI was concerned the five-year benchmark was too low to protect buyers against adverse events. In June, 2021, the most recent update, OSFI decoupled the minimum qualifying rate from the central bank’s posted rate. It has now a set floor rate of 5.25 per cent that the regulator will review annually.

By requiring buyers to qualify at a higher rate than they’re actually being offered, the stress test makes it more difficult for Canadians to get a mortgage. It can reduce the mortgage amount you qualify for or require you to save more money for a larger down payment.

When the stress test came in for uninsured borrowers in 2018, it cut purchasing power by about 22 per cent, according to the National Bank of Canada. The most recent update cut buying power by 4 per cent on average. This is because lenders have limits on borrowers’ debt service ratios – the amount of their income that goes to making their payments – and pushing the mortgage rate up means they’ll hit the ceiling faster and thus qualify for smaller mortgages.

While a 4-per-cent decrease in purchasing power might sound modest, it can be significant. Last year real estate brokerage Zoocasa calculated that Canadians looking to buy the average-priced home in their city with a 20-per-cent down payment would see the mortgage they qualify for decrease by between $14,000 and $47,000. Alternately, they’d need to boost their income by between $2,000 and $9,000 annually. Those living in Toronto and Vancouver took the biggest hits to mortgage qualification amounts.

Is everyone subject to the stress test?

Anyone who takes out a mortgage with a federally regulated lender overseen by OSFI – which includes banks and federal credit unions, and trust and loan companies – must face the stress test. Provincially regulated lenders like most credit unions, as well as alternative lenders, are not subject to the stress test rules. Some of these lenders will stress test you anyway to gauge the risk of lending to you, but they have the discretion to decide to approve you for a mortgage regardless.

However, if you’re an insured borrower you’ll be subject to the stress test regardless of the mortgage you choose.

If you’re renewing or refinancing your mortgage and decide to switch lenders, you’ll also likely need to pass the stress test. However, according to Robert McLister, a mortgage strategist with and a Globe contributing columnist, there is an exception. If you were approved for a CMHC-insured mortgage prior to the introduction of the stress test in 2016, some lenders can “grandfather” you and qualify you at their actual five-year fixed rate.

Who is most affected by the stress test?

The stress test tends to disproportionately affect those who are just on the margins of qualifying, who are typically “buying the most house they can afford,” said Mr. McLister. And that’s a lot of people. According to the CMHC’s 2021 mortgage consumer survey, 65 per cent of buyers paid the maximum price they could afford to buy their home.

Does the stress test apply to both variable and fixed-rate mortgages?

You’ll have to undergo the stress test regardless of whether you opt for a fixed- or variable-rate mortgage. With variable rates consistently lower than fixed rates, Mr. McLister said choosing to be stress tested at a variable rate will likely help you qualify for a bigger mortgage than you would be able to achieve on a fixed.

As an example, an uninsured buyer who went with the lowest available five-year fixed rate as of August, 2022 would be stress tested at 6.79 per cent; if they went with the lowest available five-year variable rate, they’d be tested at 6.15 per cent. Mr. McLister said that in this case, a hypothetical uninsured buyer who’s making $100,000 a year, doesn’t have other debts and takes a 30-year amortization period, could qualify for a home that’s 5.4 per cent more expensive with a variable rate.

How have rising interest rates affected the stress test?

Recent rate increases show the huge impact that the hikes can have. The Bank of Canada, in an effort to tame rising inflation, made a series of interest rate hikes in 2022, including a supersized 100-basis-point hike in July that brought its policy rate to 2.5 per cent. (A basis point is one-hundredth of a percentage point.)

After two years of rapidly rising housing prices, rate hikes have started to cool the market – but they’ve also sent borrowing costs soaring and made the stress test much harder to pass. The minimum qualifying rate of 5.25 per cent is “no longer a factor,” Mr. McLister said, because it’s less than the lowest contract rates available on the market plus two percentage points. As of August, 2022, the easiest stress test rates for insured and uninsured buyers, based on the lowest nationally available interest rates, are 5.45 per cent and 6.15 per cent, respectively. (Insured buyers are typically offered lower rates because their lender is guaranteed repayment even if they default.)

According to loan comparison website, the yearly income needed to purchase the average Canadian home at a fixed mortgage rate with 20 per cent down has climbed by an average of $18,000, owing to these higher stress test requirements as of July. Vancouver buyers need to make a minimum of $232,000 a year to afford a home in the city – a nearly $32,000 increase since March – and Toronto buyers need to make roughly $226,000, an additional $16,000 in the same time frame.

“I’ve seen over the last few months it’s really impacting buyers’ ability to buy what they want in real time, one month to [the next] after the Bank of Canada has increased its rates,” said Davelle Morrison, a Toronto broker with Bosley Real Estate Ltd.

If rates keep climbing – as many in mid-2022 were expecting them to – then the stress will become progressively tougher for borrowers.

OSFI is leaving the door open to tweaking the mortgage stress test rules before the end of 2022 to address these new circumstances, Globe real estate reporter Rachelle Younglai reported in May.

Can you get around the stress test? What are the benefits and risks of doing so?

If you’re an uninsured borrower and choose to work with a private lender, mortgage investment company or provincially regulated credit union, you’ll likely be able to skirt the stress test – or, if your lender applies it, they may not reject you if you can’t pass the higher rate. “A debt service ratio shouldn’t make or break a mortgage decision in isolation of other factors,” Allison Van Rooijen, vice-president of consumer credit at Meridian Credit Union, told The Globe in August.

There are tradeoffs to this, Mr. McLister said: These lenders tend to offer interest rates “materially higher” than OSFI compliant mortgages. But this isn’t necessarily a bad thing, he said. As an example, if you went with a credit union that offered an interest rate that was 0.5 percentage points higher than a major bank’s, the credit union would still be able to qualify you for more financing because you don’t have to clear the hurdle of qualifying for two points higher than your contract rate.

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