Once you’ve decided that you’re going to buy a home, you need to determine what you can afford, the required down payment, and how to get a mortgage pre-approval.
In 2016, when interest rates were at a record low, the federal government introduced the mortgage stress test as a way of making sure borrowers would still be able to make their mortgage payments if interest rates were to climb higher by qualifying borrowers at a higher interest rate than their contract rate, thus decreasing the overall amount that they were allowed to borrow.
The stress test applies to both insured and uninsured mortgages. An insured mortgage is a mortgage that is required to be covered by mortgage default insurance because the down payment was less than 20% of the purchase price. If you don’t have a down payment of at least 20% of the purchase price, you are required to obtain mortgage default insurance, which could add 2.8% to 4.0% of your total mortgage amountIf you have more than a 20% down payment, , and therefore have an uninsured mortgage. Note: properties with a purchase price of over $1 million are not eligible for default insurance and require a full 20% down payment.
The stress test requires that you qualify by calculating mortgage payments using an interest rate that is the greater of:
- 25% or
- your negotiated rate plus 2%.
The mortgage stress test in action
In today’s high-interest market conditions, almost all mortgages will be based on the negotiated rate plus 2% rather than the 5.25%.
Nevertheless, let’s look at this hypothetical example of how the mortgage stress test would come into play in a low interest rate environment:
Dr. Ellen Wise, a 32-year-old PGY-3, and her husband are ready to buy a home. Together, they have a current household income of $175,000 before tax. Thanks to family help, they have a down payment of $200,000.
Prior to the implementation of the stress test, based on a household income of $175,000 and a 30-year amortization, they would qualify for a maximum mortgage amount of $1,217,233 (with their negotiated interest rate of 2.99%), for a maximum house price of $1,417,233.
Remember, the stress test says that they have to qualify on the higher of 5.25% or their negotiated interest rate plus 2% (which would be 4.99%), so they must use the 5.25% rate instead. That means they can now qualify for a maximum mortgage of $928,153 instead of $1,217,233 — a difference of $289,080. (For simplicity’s sake, no other debt has been included in the calculation; the monthly property tax is $462, and the monthly heating cost is $100.)1
| State | Rate | Maximum affordable mortgage | Maximum purchase price (assuming a $200,000 down payment) |
|---|---|---|---|
| Pre-stress test | Negotiated rate of 2.99% | $1,217,233 | $1,417,233 |
| Post stress test | Stress test rate of 5.25% | $928,153 | $1,128,153 |
Dr. Wise and her husband’s monthly mortgage payments will still be based on their negotiated rate of 2.99%, but they will qualify for a lower maximum mortgage because of the federal mortgage stress test rules.
Note: If you’re a resident physician seeking approval for a mortgage from Scotiabank, the amount of mortgage you can qualify for may be based on your projected income, rather than your current income.2
The exceptions to the rule
The stress test is not applied to
mortgage renewals. If you renew your mortgage with your existing financial institution/lender, the stress test rules won’t apply as you do not have to re-qualify in order to renew with your existing financial institution or lender.
Before you start looking for a home, use MD’s mortgage calculator to explore your mortgage options. The right information can help you choose the mortgage solution that best fits your life.
An MD Advisor* can help you to budget and to determine how a mortgage will fit into your financial plan.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 Source: https://dmts.scotiabank.com/tools/mortgage/afford/en/index.html
2 Projected income is an average estimated amount based on available industry data and is subject to change. Your actual income may vary. Terms and conditions apply.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.
