As we’ve touched upon in previous blogs, obtaining a mortgage is typically one of, if not the largest financial decision made by most Canadians. For generations now, Canadians have been pursuing stable, middle-class lifestyles funded primarily through rising homeownership values funded by mortgage debt. Indeed, in recent months mortgage debt levels amongst Canadians rose another 7.4%, pushing the total to $1.66 Trillion according to StatsCan. For context, the entire Canadian GDP for 2021 is projected to be roughly $1.74 Trillion.

With real estate and mortgage debt playing such integral roles in the Canadian economy, it is essential that these systems be designed in a robust fashion, with failsafes in place to guard against such exigent threats as mass defaults on debts (as was so devastatingly witnessed in the 2008 sub-prime mortgage fiasco that went down in the United States).

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Enter the mortgage stress test rules

Mortgage stress tests are, at their core, exactly what they sound like: a test of the borrower’s ability to manage their mortgage debt load, even if additional financial stresses are placed on the borrowers’ ability to pay. They essentially exist in order to vet borrowers to ensure that, should a change of circumstance arise such as an interest rate increase, the borrowers will still be in a sufficiently strong financial position to cover their mortgage debt obligations.

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What's the story of the mortgage stress test?

In Canada, the Mortgage Stress Test originated with the Office of the Superintendent of Financial Institutions (OSFI) Guideline B-20. This guideline, intended for all federally regulated lenders (such as banks, loan companies, etc.), requires “lenders to assess a borrower’s ability to pay their loan under a variety of loan conditions. A lender should consider potential changes to a borrower’s income and expenses, as well as changes to the market environment including the valuation of the property that is being mortgaged.”In the first iteration of the Mortgage Stress Test Guidelines, the stress test was only applicable to borrowers who were applying for mortgages with less than a 20% down payment, and, as such, were liable to pay for mortgage default insurance premiums. However, since the beginning of 2018, all candidates applying for a mortgage from a federally regulated lender must pass the mortgage stress test (even when applying with more than 20% down).

Note, this new update to the guidelines applies even to existing mortgages, should the borrower decide to switch lenders at the end of their term, they will be subject to the mortgage stress test.

What you need to know about passing the mortgage stress test

Just as with any test, the Mortgage Stress Test is far easier to pass if one is well prepared. The first factor to consider is the level of debt that you are already shouldering, prior to your application for a mortgage. When evaluating whether or not an applicant will pass the Stress Test, mortgage lenders will consider a borrower's Gross Debt Service (GDS) Ratio, and their Total Debt Service (TDS) Ratio as key indicators of a borrower’s financial health, and their projected ability to repay their mortgage debt.

‍The Gross Debt Service (GDS) Ratio measures what proportion of their total income an individual must put towards their housing debt. Investopedia recommends that borrowers should aim for a GDS Ratio no greater than 28% of their income.Meanwhile, the Total Debt Service (TDS) Ratio measures how much of your income is required to cover all of your outstanding debt obligations, including but not limited to: credit card debt, car loans and student debt. Borrowers who have a TDS Ratio in excess of 43% will be unable to obtain a mortgage from most, if not all, qualified lenders; and indeed, lenders are increasingly trending towards an acceptable TDS Ratio of around 36%.When preparing to pass the Mortgage Stress Test, it is recommended that you first ensure that your high-interest-bearing debts (such as credit cards) are paid off to their fullest so as to lower your TDS Ratio. If, after clearing what debts you can, you are still unable to pass the Mortgage Stress Test due to your various Debt Service Ratios it is recommended that you re-evaluate the size of the loan for which you are applying, or, seek an alternative option.

Alternative options to a traditional mortgage

If after evaluating your options you decide that you will either be unable to pass the Stress Test or, you decide that you do not want to take on a mortgage from a federally regulated lender for whatever reason, there are alternative options for participating in the real estate market.One such option, alluded to above, is to obtain a loan from an alternative lender. If this is an option that you would like to pursue, Loans Canada can help connect you with a lender who meets your needs. It is important to note however that rates from alternative lenders will tend to be higher, and thus more expensive in the long run, than federally regulated lenders.Another option is to forego the need for a mortgage altogether by utilizing an alternative ownership method, such as Key.

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