As of June 1, 2021, homebuyers will face the mortgage stress test rules that will decrease the buying power of most borrowers. Both insured and uninsured mortgage borrowers will be subject to a stricter stress test when qualifying for their mortgage.
If you’re buying a home, the mortgage rules will have a direct effect on how much home you can afford. You have to prove that you can still make your monthly mortgage payments if interest rates were to rise in the future. Already have a mortgage? You’ll face a mortgage stress test if you refinance your home, take out a homeowner line of credit, or switch to a new lender (but not if you renew with the same lender).
The new qualifying rate on uninsured mortgages – where the down payment is 20% or more – is now either two percentage points above the contract rate or 5.25%, whichever is higher.
So, if your lender offers a rate of 2.99%, you’ll have to use the 5.25% qualifying rate in your stress test. If your lender offers a rate of 3.49%, you’ll have to qualify using a rate of 5.49%.
Although the new mortgage qualifying rate is intended to protect the Canadian housing industry, the changes also mean that you might have to settle for a lower budget or higher down payment on your mortgage. The qualifying rate will be revised at least once a year by the Department of Finance or OSFI to ensure it remains appropriate for the risks in the environment.
Let’s assume a household income of $100,000 and a down payment of $100,000. You might have been able to afford a $463,000 home roughly, based on mortgage rate of 2.24% and previous qualifying rate of 4.79%.2 With the new qualifying rate of 5.25% and same mortgage rate, the maximum home price you could afford is now reduced to around $447,000 (roughly 4% lower). To afford the same home as before under the new stress test rules, you would need to make up the difference by adding $16,000 to your down payment.
Example (Taken from Bank of Montreal)
Say you bought a $726,000 house with a $150,000 down payment at 2.30%. Your monthly mortgage payments for a 25-year amortization would be $2,523. If you were to “stress-test” your mortgage payments under the old rules, you’d apply the minimum stress test rate of 4.79%, which means that to pay off the same principal amount as the previous rate, your monthly mortgage payment would increase to $3,282, which is a 30% increase. Basically, you want to show that you could still handle your payments if rates were to rise. Under the new 5.25% fixed rate introduced in June 2021, the stressed monthly payment would be $3,432.
How to pay off your mortgage before a rate increase?
Rates may not actually go that high overnight, but an increase of one or two percentage points over a longer period is a real possibility.
Most variable rate mortgage providers in Canada won’t increase your payments straight away. Instead, you’ll pay the same amount as before the rate increase, but less of each payment would go towards the principal. That means, in order to pay off your mortgage in the agreed-upon amortization period, you might have to make a tough choice.
Here are your options:
Increase your monthly payments: You could either increase your monthly payments immediately or wait until your term ends (but it’s a good idea to increase your monthly payments sooner rather than later – if you can afford it).
Make a lump sum payment (or multiple payments): Making a lump sum payment compensates for the fact that you’re paying off less of your principal each month. You could make this payment pretty much any time, depending on your mortgage prepayment rules, but the sooner the better.
Do nothing: You could continue to pay the same regular payments as before the rate increase (with less of each payment going towards your principal) and wait until your term ends. Once your term ends, however, you’ll have to either increase your monthly payments, or make a lump sum payment to ensure that you pay off your mortgage by the end of your amortization period.
Deciding which option is right for you is a big decision and one that you should consider making with the help of a professional. Even in the best of circumstances, a large increase in mortgage rates could prove to be a lot to handle. If your household brings in $6,000 per month after taxes and your mortgage payment increased to $4,000 then you’d be spending over 66% of your monthly income on mortgage payments alone.
Spending that much on your mortgage can leave you in a vulnerable financial position, but you don’t have to do it alone. Speaking with a mortgage specialist can help you find the option that suits your needs.