There are people who brace themselves for the worst every day. It is the reason why people carry an umbrella in case of a sudden bad weather. Bracing for the worst should apply to all life-altering decisions like getting a house mortgage.
A mortgage is a commitment that lasts for an extended amount of time. However, what happens if, during the course of those years the borrower suddenly lost a job or had a financial emergency? Fortunately, we those situations are now amendable today. It is the reason why, one needs to pass a mandatory stress test before qualifying for a mortgage.
What is a Mortgage Stress Test?
In finance, planning for the worst possible case scenario is called the ‘Stress Test.’ As the name implies, it tests how a borrower and their finances can handle sudden bouts of financial turmoil. It includes modeling or portraying an adverse scenario before securing a mortgage. It is a test that can help determine how much they can afford and under what circumstances.
Simply put, this test enables people to face and realize the extremely high costs of home buying. To pass the test, homebuyers must prove that they can afford the mortgage at a qualifying rate.
Homebuyers must consider worst-case scenarios like losing a job, reduced income, or interest rate spikes. That type of planning matters for a few reasons. First and foremost, interest rates constantly fluctuate, and this includes home prices.
Knowing whether they can afford the mortgage no matter if the interest rates rise or fall is vital to understand because it can affect their prospective home purchase.
What is the Purpose of the Test?
For starters, the test is implemented to answer the concern of the mortgage industry growing too large and fast in Canada. As a matter of fact, this sudden rise could potentially endanger the country’s economic stability. It is why the test also serves as a response to the household debt issue of the country.
Another primary purpose of the test is to protect homebuyers. Since interest rates have been low, it can and will go up. Therefore, the banks and the government want to assure that homebuyers would be capable of paying their mortgage even if the rates spiked.
What are the Changes in the Test in June 2021?
Homebuyers must know about this test, including being up-to-date with its changes and the mortgage regulation.
When a homebuyer decides to apply for a mortgage, they will be presented with a contracted rate. However, the bank will need to check whether they can pay back, even if the mortgage rate spikes up during their term. The bank evaluates the homebuyer’s ability to pay by depending on the Bank of Canada’s qualifying rate, 4.79%. However, starting June, there will be a couple of changes in the test, specifically on the qualifying rate.
As of June 2021, the qualifying rate increased. The rate will increase to either an additional 2% to the mortgage contract rate or 5.25%, whichever will be higher.
According to Ben Gully, the OSFI (Officer of the Superintendent of Financial Institutions) assistant superintendent of regulation, the changes will help with financial resilience should an economic circumstance change. He also said that it could contribute to confidence in the financial system of Canada.
Who Will Be Affected By The New Rules?
These new test rules will impact Canadian homebuyers who are renewing or applying for a mortgage. It also affects uninsured mortgages (with 20% or more down payment) and insured mortgages (with less than 20% down payment).
There is also no way to side-step this test. The big banks in Canada must implement these rules, while some lenders use them voluntarily to decrease risk exposure.
While the mortgage stress test changes can be a bit overwhelming, it does help in the long run. This test will help homebuyers prepare for the worst-case scenarios. Furthermore, this test can help them prevent digging a financial hole that can potentially be too deep to escape.