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Mortgage stress test explained: Can you actually afford your next home?

“Always pick your yard based on your Summer lifetstyle.”

~ KARL

September 6, 2018 - Karl Yeh

"The mortgage stress test is technically what we look at with the Bank of Canada has come back to the banks to look at extreme what-if scenarios to see what happens if, at a certain time, mortgage rates have gone a lot higher than at the time the clients have qualified to see if they can still afford to pay their mortgage."

How does the mortgage stress test affect your ability to buy a home? Just how much can you afford? In this episode, we build upon our previous video on the new mortgage rules and mortgage stress test. We explore how the stress test is applied for those who put more or less than a 20 percent down payment. We review how the stress test impacts variable and fixed rate mortgages, what income you need to pass the stress test and if you can avoid it. Finally, we discuss how the recent interest rate hikes have affected the test. 

 

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Transcription:

Karl Yeh:

Hi, everyone. Welcome to another Homebuyer's School video, a channel where you get the latest strategies, tactics, and tips from home buying experts.

Remember, if this is your first time on this channel and you want to get the latest strategies from the experts, hit the subscription button below, hit the little [00:00:30] notification bell, so you don't miss anything.

Today I'm joined by Mujtaba Syed, Manager Mobile Mortgage Specialist with TD Canada Trust.

Today we're going to explain a little bit further on:

What exactly is the mortgage stress test?

Mujtaba Syed:                  

Yeah.

The mortgage stress test is technically what we look at with the Bank of Canada has come back to the banks to look at extreme what-if scenarios to see what happens if, at a certain time, mortgage rates have gone a lot higher than at the time the clients have qualified to see if they can still afford to pay their mortgage.

For example [00:01:00] , if someone actually qualified for a mortgage and their interest rate is let's say 2.59 a couple of years ago, and at the time of renewal now, interest rates have jumped to 5.34 or 6%, whatever's available and they have no choice but to renew at those rates, What the payments are going to look like? Can they really afford those payments?

Keep in mind, we did have historically low mortgage payments for the longest time and lot of people were just on the brink of qualifying for their [00:01:30] houses at that time, at those rates but those rates are not going to be available for too long.

They might not be available when you come off for renewal.

The Bank of Canada and the banks also want to see that at the time of renewal, are you going to be able to afford that mortgage today? Five years from today? Six years from today? Ten years from today? So they actually put that stress test in as a what-if scenario to see sure the rates are not a certain amount today but they could be in the future.

Is there a guarantee? No, but there's a possibility.

They want [00:02:00] to see that if you can afford the payments then, then you shouldn't be having any issues to get qualified today and that you can afford to make your payments at any given time.

That is shouldn't, in a nutshell, what is a mortgage stress test.

Karl Yeh:                             

I know there's a difference between putting more than 20% down and less than 20% down, right?

We do have a video on the mortgage stress test actually explained in the video above.

 

but I remember when we talked about it last time, if it's above [00:02:30] 20%, you don't need mortgage insurance, right? But you still need to do the stress test?

Mujtaba Syed:                   Mm-hmm (affirmative).

Karl Yeh:                             If you have less than 20%, you need mortgage insurance but you still need to do a stress test, right?

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Is the mortgage stress test different or the same if you put more or less than a 20% down payment?

Karl Yeh:                              Now, is the stress test different for either or is it the same stress test?

Mujtaba Syed:                  

Yeah, so when it first started off the stress tests were just for insured mortgages. So that means if you're putting less than 20% down, you had to deal with the stress test scenario.

Then, as of last year (2017), they actually made that across the board for everyone. Whether you're putting 20% [00:03:00] down or less than 20% down, everyone needs to kind of qualify.

In a way it's an inconvenience, for sure, but it's better overall for our housing industry and for the economy so we fell like everyone can afford their payments.

1. Less than a 20% down payment

Then, you're absolutely right, Karl, the stress test definitely does differ, if you're putting less than 20% down, it's a very simple calculations, a simple formula to look at the Bank of Canada five-year posted rate then qualify you on that. No questions asked.

2. More than a 20% down payment

Now, if you're putting more [00:03:30] than 20% down, they can take a look into a lot of different scenarios. They can take a look at to see what your term is, what term are you getting and then, they can charge you a two percent premium on top of that.

Or the five-year posted Bank of Canada rate whichever is going to be greater.

You definitely want to have that conversation with your lender to see.

Does it make sense for me to go with a five-year fixed if the five-year fixed, today is 3.6, 3.7 that's going to make my qualifying stress test at 5.7 which is a lot higher than the Bank of Canada five-year [00:04:00] posted rate at 5.34. Or if you decide to go with something like a home-equity line of credit product that we say. They could take a look at to see whatever your pricing is and charge you a higher two percent premium on that.

Once again, a great discussion to have with your lender and your specialist to see what is best for you.

Also, kind of go into terms to see what's the best rate and term for your financial picture or your monthly budgeting.

How to decided between putting more or less than a 20% down payment? 

Karl Yeh:                             

If you had a choice right now, let's say as a homeowner or potential home buyer, [00:04:30] I'm deciding between putting down 20% or more or less than 20% and getting an insured mortgage, is there advice on whichever one or is it sort really focused on your lifestyle and more personal?

Mujtaba Syed:                  

Yeah 100%. It's 100% based on your personal preference, and your lifestyle and your budgeting to see what's available, right?

Obviously, the more you put down, the less interest costs, you don't have to come up with CMHC or default insurance premiums which could be a lot and then they're factored right into your mortgage.

[00:05:00] It means that now you're going to be paying interest on that. Sometimes it's going to be compounding interest.

Or you take a look at the fact is now I don't have the 20% but now I might need to save up longer or I might need to have my family help me out or ask them for help or borrow to do a certain amount.

Then, you have to see if that's really worth it for you.

Maybe, buying a house, today and getting a cheaper price, lock in price today instead of waiting a few years to save up that extra 20% you might miss out on the market. You might miss out [00:05:30] on any appreciation your house can do in that time.

So it's a very personal preference but it's a great discussion to have with your lender. If you can explain to them your concerns and your scenario and they can advise you on what's best to do.

Maybe sometimes it's not best to wait a couple of years to save up that 20%. Maybe the appreciation in that time will be a lot more?

Maybe three years from today if you get a lot cheaper house and that same out is now costing you a lot more and you've haven't really done yourself any benefit by saving up to get that extra [00:06:00] 20%.

Once again, really have that discussion, go with your personal preference, find out the pros and cons for both. Learn about products and then decide what makes sense for you.

Karl Yeh:                             

Now, let's say you're on a fixed or a variable mortgage rate. Does this stress test have any impact on you?

Mujtaba Syed:                  

Once again, it just really just depends if you're an insured product or not.

If you're putting less than 20% it doesn't matter at all, if you're going with a fixed or a variable, everyone will qualify at the five-year Bank of Canada posted [00:06:30] rate.

Now, if you're putting more than 20% to 100%, it will impact you. If you're going with a fixed rate, they are just going to charge you that two percent premium of whatever your fixed rate is.

Fixed rate at more than 20% down payment

So, if your fixed rate is 3.6, 3.7, there's going to be a two percent premium on that which is going to be 5.7.

Or, if it's less, lets say it's 2.5 for a five-year posted rate, they can charge you two percent, it will be 4.5. Then, at that time, they will look at to see what the five-year Bank of Canada's posted rate is.

They look at the benchmark at 5.34 and [00:07:00] whatever is greater than that, so if your five-year posted rate is greater than the benchmark, that is what your stress test.

If your five-year posted rate is lower than the Bank of Canada's posted rate, then you qualify at the Bank of Canada's posted rate.

Variable rate at more than 20% down payment

For variable, even for a conventional mortgage which is when you put more than 20% down, you always qualify at the five-year posted rate.

That's just because it's a variable, we just have no idea, right? They fluctuate, they can go up and down. So for us to us a stability stress test, we will just use the Bank of Canada's [00:07:30] five-year posted rate.

Karl Yeh:                             

What income do you need to actually pass a stress test? Or is there and income level?

Mujtaba Syed:                  

It really just depends. You'll probably you can go online, you can see some graphs.

What I like to do and explain to my clients and say, the best thing to do is to really just come in and have that discussion. Start a process, try out the pre-approval to see exactly where you can qualify.

There's a lot of guesswork that goes into it.

There's some credit requirements that we take a look at.

For example, if your beacon score is at a certain number, it affects our ratios. [00:08:00] If you're above 680, the banks can actually go to a maximum 44% of your ratios. If your credit is not the best, if it's lower than 680, that ratio automatically now drops to 42%. There's some other ratios we take a look at.

 You can find these calculators online. You can find these graphs online but it's not going to be a good indicator of to see how much you can qualify with the new stress test.

The stress test has really definitely impacted qualifying as a whole. The best thing to do is to go in and talk to a specialist. [00:08:30] Talk to someone who is a professional and who can advise you on what to do and really get a proper number done.

Don't look online and then write an offer on a house.

The worst thing we would want you do to is you fall in love with the house, you write an offer and then you realize, after that, that you don't qualify for that because you maybe not have met the credit requirements or maybe some information you read online was not accurate enough.

Definitely, go in, see a professional, see your lender, see a specialist and do a proper pre-approval process so you can actually [00:09:00] when you go shopping, which should be the most funnest part of the house hunting experience, is you can go in there with confidence knowing that I know I'm approved for a certain amount and I can get that house.

Karl Yeh:                             

Is there any way to avoid the stress test?

Mujtaba Syed:                  

Unfortunately not.

There is no way to avoid the stress test at all. Every Canadian who is looking at purchasing a house has to go through the stress test.

The sooner we can recognize that and learn the benefits of stress tests. Stress test is an inconvenience [00:09:30] but, overall, I think it is a benefit for the banks to have and for us to have so we don't see a major financial crisis or a crash that we've seen happen in other countries.

Very similar to what happens with mortgages when people can't pay.

So the sooner we get to realize that the stress test is not going anywhere, it's going to be around, the best thing to find out is to see how much can I qualify now with a stress test?

Then, kind of see maybe we drop down our purchasing price a little bit [00:10:00] and see if we can qualify for whatever is comfortable for us.

At the end of the day, we still have to end up making that payment and a home ownership experience is a long term experience, right? It's not you jump into your first home and that's going to be your forever home, forever.

Maybe you start off with something like a starter home and then, you work your way up to see once your financial situation gets better.

A stress test can really help us kind of realize that and get to what our dream home could be in the future.

Karl Yeh:                              Now, finally, the last question I have for you is, [00:10:30]

Has the recent interest rate hikes impacted the stress tests at all?

Mujtaba Syed:                  

Yes they have. Once again, if it's a conventional product, if you're putting over 20% and you've decided to go with a five-year fixed rate, if the rates go up, like I said, there's going to be that two percent premium on top of your five-year fixed rate so that would actually raise your stress test as well.

Meaning it would actually change your qualifications and you would have to qualify at a higher rate, that means you might qualify for a little less.

Once again, speak with your [00:11:00] specialist, your lender and see exactly where you stand even after the rates have gone up.

 

Karl Yeh:                              So my question for you is:

Has the recent mortgage stress test impacted your ability to buy a home?

Let us know in the comment section below.

So, Mo, do you have anything else to add?

Mujtaba Syed:                  

No, I think that's great. Definitely reach out to your bank, go speak to your lender or your specialist and have the proper pre-approval done so when you go shopping around, you can shop around with confidence.

Karl Yeh:                             

Remember to watch our mortgage-related videos in the playlist [00:11:30] in the description below.

Thank you very much for joining us and we'll catch you next time.

 

Your turn:

Let us know if you have additional mortgage or financing related questions that we can answer by submitting them in the comments section below. 

Homebuyer's School publishes new content weekly so subscribe or check back regularly for the latest information, strategies and tips from home buying experts.  

About Mujtaba Syed:

Mujtaba is an experienced mobile mortgage specialist with a demonstrated history of working in the banking industry. Skilled in Negotiation, Commercial Lending, Banking, Sales, and Credit Analysis. Strong product management professional.

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