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What is the Canadian Mortgage Stress Test?

    A mortgage “stress test” helps to plan for the worst-case financial scenario. It involves modelling to figure out how much a person can afford to borrow when buying a house, should the individual fall into dire financial circumstances. What if a job is lost or income is reduced? What if interest rates were to increase or there was a need to refinance the house? Could the borrower still make the payments on their mortgage, if situations like the above were to arise?

    Since 2018, all Canadian homebuyers receiving high-ratio mortgages were subjected to a mortgage stress test, and currently, this applies to all mortgage applications. A high-ratio mortgage is one where the mortgage loan is greater than 80%, meaning the borrower had less than a 20% down payment towards the house when applying for the mortgage. These types of mortgages are also referred to as “insured” mortgages, as mortgage loan insurance is required for high-ratio mortgages.

    Financial institutions use Canadian mortgage stress tests to ensure that borrowers can make their mortgage payments at a rate that is increased to what they will need to pay. When someone applies for a mortgage now, they are offered a contracted rate, and mortgage lenders are required to review whether or not they’ll be able to pay back the determined amount if interest rates increase during the mortgage’s term.

    Banks check a borrower’s ability to make mortgage payments through this stress test as per the qualifying rate for the Bank of Canada (BOC). This is based on the posted five-year fixed interest rates from the BOC. Ultimately, a person’s income needs to be at a level where a mortgage can be paid down with a higher interest rate; existing debt also needs to be factored into that equation. To “pass” a Canadian mortgage stress test, borrowers need to either meet the qualifying requirements at their contracted mortgage interest rate, plus 2%, or the BOC’s five-year median posted rate – whichever of these two is higher. 

    Canada’s mortgage stress test was originally developed to help with the issue of household debt and to prevent homeowners from accumulating even more debt by getting a mortgage that was not affordable. The average Canadian household’s disposable income is indebted at 170%, which means $1.70 is owed for every dollar made, after taxes. Therefore, to assist with this, the Office of the Superintendent of Financial Institutions Canada (OSFI) suggested some changes to Canada’s housing and mortgage rules in the summer of 2016. One change was to implement a new “stress test” that was mandatory for prospective homeowners looking to borrow funds via federally regulated lenders, like financial institutions. 

    It’s important to note that in the spring of 2020, Canada’s Department of Finance did announce a possible update to the mortgage stress test and how the rate would be calculated moving forward; however, due to the COVID-19 pandemic, the implementation was pushed back. The changes would have come into effect on April 6, 2020, and the qualifying rate was to be set at the weekly average five-year rate for insured mortgages. For now, the new system has been delayed, but it is expected to be applied once the Canadian economy recovers from the COVID-19 pandemic.

    There is no way to avoid a mortgage stress test in Canada; however, it was designed for federally regulated banks, so some mortgage lenders (i.e., private lenders or credit unions) that are not under the OSFI, do not place borrowers under the stress test modelling during the mortgage application process. 

    The best way clients can pass a stress test is by paying down debt before applying for a mortgage, and work on saving a good down payment for their house. Lenders assess the total debt service (TDS) ratio when they process any type of loan, including mortgages, which is the gross income earned, minus accumulated debt. By enhancing savings and paying down debt, individuals can overcome a major obstacle during their mortgage application and Canadian mortgage stress test modelling.

    For those thinking about applying for a mortgage, but worrying about the Canadian mortgage stress test, there are multiple calculators that can be found online to help offer some insight. 


    Christopher - BSc, MBA

    With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.

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