With inflation near a 40 year high, the Bank of Canada has increased interest rates at the fastest point in 30 years. Let’s look at what the means for the mortgage stress test.
What is the Mortgage Stress Test and Why Was it Put into Place?
The mortgage stress test was put into place by the government to protect homebuyers in case rates went up.
Before the stress test existed, homebuyers only had to qualify based on the rate of the mortgage. This was fine and dandy, but what if mortgage rates were higher at renewal? This would mean that a homeowner could see their mortgage payments jump on renewal.
This could especially affect a homebuyer that goes with a shorter-term mortgage. If you go with a 1- or 2-year mortgage term, you’re a lot more susceptible to rate hikes than someone with a 5 year mortgage term.
Fixed rate mortgage holders aren’t the only ones with risk. Variable rate mortgage holders have risk as well.
If you chose a variable rate mortgage and rates go higher, your mortgage payment could become unaffordable during your term if you have an adjustable-rate mortgage. This is a mortgage where your payments change as prime rate changes.
Even those with variable rate mortgages where their payment is fixed could see their payment increase if they locked in when rates were lower, as their payment may no longer be enough to cover the interest portion of their mortgage.
What’s Going on in 2022
2022 has been an interesting year so far. In 2021 it seemed like the Bank of Canada was going to take it sweet time increasing interest rates. That’s before Canada saw record inflation. This forced the Bank of Canada’s hand and moved up plans to increase interest rates.
The mortgage stress test rate currently sits at 5.25%, however, with higher mortgage rates, homebuyers are now having to qualify based on their mortgage rate plus 2% for the first time in quite a while.
With the latest prime rate increase of 0.75% in September, now variable rate mortgages in addition to fixed rate mortgages are being forced to qualify at their mortgage rate plus 2%. Previously it was only fixed rate mortgages, as they came with higher interest rates.
Because of the rate increases, homebuyers have seen their home buying power drop by 10% to 15%, as homebuyers most prove they can handle mortgage rates of 6% and even 7% in some cases.
If you’re finding your homebuying power squeezed, the good news is that there are still options. There are credit unions out there who still qualify you based on the mortgage rate. Likewise, some alternative lenders will be willing to as well.
It’s a good idea to review all your options, as it may be worth taking a slightly higher rate if it means being able to spend 10% or more on a home. This especially makes sense in expenses markets like Toronto and Vancouver.