By Sean Cooper, for Loans Canada
Special to the Financial Independence Hub
With higher rates arriving sooner than expected, Canadian’s finances are certainly being stress tested. In this article we’ll look at the history of the mortgage stress test and how higher rates are impacted it.
History of the Mortgage Stress Test
The mortgage stress test was introduced by the federal government several years back to stop homebuyers from overextending themselves. Previously, Canadians homebuyers only had to qualify based on the mortgage rate at the time of application. This was problematic for a couple of reasons.
First of all, mortgage rates could be higher when your mortgage came up for renewal. This could mean that you could face a much higher payment at renewal if mortgage rates were a lot higher then.
Most Canadians choose a five-year mortgage term. However, for those who chose a shorter mortgage term, that means the payment shock can be that much more if your mortgage comes up for renewal sooner.
The second reason it was a problem is that if someone chooses a variable rate mortgage, there’s really no limit to how high mortgage rates can go. You’re only asked to prove that you can qualify at the date that you applied. You’re not being asked to qualify again later on if and when rates rise.
What is the Mortgage Stress Test?
To avoid a similar meltdown as Americans experienced in the real estate market, the mortgage stress test came to be.
With the mortgage stress test, the borrower must prove that they can qualify at the greater of the stress test rate or your mortgage rate at application time plus 2%. The idea was to better protect homebuyers, but this came at a cost. Homebuyers saw their home purchasing power drop by 15% to 20% overnight. This is a direct result of having to qualify at a much higher rate.
Where we are Today
We’re in an interesting situation today. The mortgage stress test is still here. We’re seeing it put to good use, as interest rates are increasing faster than expected. Continue Reading…