No one likes to fail a test — especially when what’s at stake isn’t a bad grade on a calculus exam, but the place you’d love to call home.

In January 2018, new mortgage rules were introduced that require all Canadian homebuyers to take a stress test in order to qualify for a mortgage from a federally regulated lender — this usually means one of Canada’s five major banks. The mortgage stress test is a calculation used by regulated lenders to determine if homebuyers can keep up with their mortgage payments if interest rates were to rise. Prior to this, only homebuyers putting less than 20 percent on a downpayment were required to stress test their mortgage.

Photo: CreditRepairExpert

“The stress test provides a cushion for homebuyers to make sure they are financially ready in all scenarios,” explains Jared Ksenica, Regional Vice President, Mortgage Specialist Sales Force (GTA) at BMO. “Even prior to the stress test being introduced, I’d always encourage buyers to personally stress test their mortgages. It’s a good practice for homebuyers to check and make sure that they will still be able to pay off a mortgage, if interest rates rise.”

That two percentage point increase directly impacts how much house you can afford or if you’ll be able to step on the property ladder in the first place. How do you determine if you’ll pass with flying colours? There are a number of ways to find out — from what banks look for to the minimum income currently required in different cities across Canada. We spoke to a BMO Mortgage Specialist, a personal finance advisor from the New School of Finance and a Canwise Mortgage Agent to help you get an A when you test yourself against the mortgage stress test.

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How the stress test is calculated

If you’re contributing at least 20 percent to your downpayment (meaning you’re an uninsured homebuyer) — you will have to meet either the Bank of Canada’s five-year benchmark rate (currently sitting at 5.34 percent) or the rate offered by your lender plus 2 percentage points. Whichever percentage is higher will be the rate you have to test your finances against.

Planning to put down less than 20 percent? You will default to an insured mortgage and will also be measured against either the Bank of Canada’s rate or the rate offered by your lender (without adding 2 extra points). The higher number wins, once again.

Already have a mortgage? You’ll face the stress test if you refinance your home, take out a homeowner line of credit, or switch to a new lender. If you renew with the same lender, you’ll be exempt from the test. This exemption has spurred criticism that the mortgage stress test is chaining homebuyers to their current lenders.

Even though you’ll still be paying the contracted interest rate, you have to prove to your lender that you have the money in the bank to meet the benchmark rate. The mortgage stress test is designed to protect homeowners from excessive debt and unaffordable mortgage payments. But for most, it also means qualifying for a home that costs around 20 percent less than they would have been able to afford prior to the 2018 mortgage rules.

Photo: James Bombales 

What banks look for to see if you qualify

“When looking to see if a prospective homebuyer will qualify for a mortgage, we consider overall
affordability,” explains Ksenica. “What this means is we look at the total debt service ratio (TDS). This accounts for all monthly debt obligations like car payments and credit cards. We also look at gross debt service ratio (GDS). GDS is the percentage of a person’s income needed to pay all of their monthly housing costs. The general rule is 40 percent TDS and 32 percent GDS, meaning that a homebuyer would need to come in below both to qualify,” he says.

To calculate GDS, add up the amount of principal you pay each month with interest, property taxes, heat and 50 percent of condo fees (if applicable). This is referred to as PITH (Principal, Interest, Taxes and Heating). Then divide this by your gross monthly income.

To calculate your TDS, take the PITH, plus 50 percent of condo fees (if applicable) plus all other monthly debts you may have (car loans, credit cards, lines of credit, student loans and the like) and divide this by your gross monthly income.

If you are looking to determine different scenarios on monthly payments, Ksenica recommends crunching the numbers on BMO’s online mortgage payment calculator.

“There are different parameters like payment frequency and amortization that can impact monthly payments and will give homebuyers a good idea of where those payments will sit,” he says.

“Something to note as well is the closing costs of a home purchase which includes the Land Transfer Tax and estimated lawyer fees,” says Mike Bricknell, a mortgage agent with Canwise. “If you are in Toronto proper then there is a 3 percent fee based off the purchase price. The rest of Ontario would pay 1.5 percent. First-time homebuyers will receive a Home Buyers Plan rebate but the funds must be in your bank account for at least 90 days which is the minimum requirement by most lenders.”

Photo: James Bombales

Aim for a mortgage no more than four times your income

Another rule of thumb is to avoid a home that exceeds more than four times your income minus all other debt payments.

For example, if you have no debt and earn $80,000 a year, look for a home that is no more than $360,000. Having no debt is a big “if.” BMO reported on the 2018 Home Owners Survey that 83 percent of participants reported having debt (13 percent claimed they have “a great deal of debt,” 42 percent had “some debt” and 28 percent said they “have little debt.”)

So if you have $15,000 left on your student loans and $5,000 in credit card debt, you should subtract it, bringing your new house maximum to $240,000 ($80,000 for your income minus $17,000 in debt times four).

This is the minimum income you’ll need across Canada to buy a home

In cities like Toronto and Vancouver, you will need an income north of $100,000 to be able to afford the average home price. In these markets, the stricter mortgage rules are pushing buyers to less expensive condos and smaller homes (driving the price of those properties up) or out of the city.

Canadian real estate company Zoocasa released a study demonstrating how you can still afford a mortgage on the average single income if you’re willing to look outside Toronto and Vancouver. The most affordable housing markets for single buyers were in Atlantic and Western Canada. In Regina (currently the most affordable market), the income required to buy the average home price is $38,798. The average single income is $58,823 — leaving ample wiggle room for comfortable homeownership.

Zoocasa assumes buyers will cough up a downpayment of 20 percent and sign on for a 30-year mortgage at an interest rate of 3.29 percent.

Passing the mortgage stress test doesn’t necessarily mean you won’t end up house poor.

Liz Schieck is a Toronto-based financial planner with the New School of Finance who helps clients avoid becoming house poor.

“We look at how much you should spend rather than how much you could spend. In my experience, this tends to be a much lower purchase price than what my clients may qualify for from a lender,” explains Shieck. “It’s about taking an honest look at your life and spending. How much do you want to travel each year? What about camps or activities for kids? Daycare? If you buy at a certain price, how much will you have left to save for repairs and maintenance? What about retirement?”

Shieck recommends ensuring homebuyers try to keep their fixed expenses (anything that is predictable and recurring) under 55 percent of their monthly after-tax income (not including bonuses, etc).

“That said, sometimes folks have their bills under 55 percent and still feel house poor depending on their spending habits or size of their family,” she says. “I think there’s often a big gap between what you can afford while staying afloat versus what you can afford without hating your life. We have seen a ton of clients pass the newer stress tests and are still taking on consumer debt to pay for things in their life because they don’t have enough cash flow to do it all. Or they are staying debt-free but aren’t able to put anything away for retirement.”

Make yourself house proud.

Sign up for Ladies on the Ladder, the first newsletter community to broadcast the diverse voices of women who have climbed the property ladder.

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