Mortgage Basics

5 Hacks to Pass the Canadian Stress Test with Confidence

5 Hacks to Pass the Canadian Stress Test with Confidence
Written by
  • Ashley Howard
| 15 January 2024
Reviewed, 15 January 2024

Table of contents

    Many Canadian homebuyers face higher home prices and interest rates, making the stress test a significant hurdle to securing a mortgage approval. The mortgage stress test was implemented as a protective measure that ensures you can comfortably afford your mortgage payments should rates increase. 

    If you’re a potential homeowner stressed about the stress test, Compare Mortgages is here to help. This post will provide you with 5 hacks that will give you an edge, providing you with the understanding required to pass the stress test and confidently qualify for your dream home.

    Key Takeaways

    • The stress test is a requirement when obtaining a mortgage with a federally regulated financial institution. 
    • You must qualify based on either the benchmark rate of 5.25% or your contract rate +2% to pass the stress test. 
    • Minimizing debt while increasing your income or downpayment are all factors that increase your chances of passing the stress test.

    Do All Lenders Use the Mortgage Stress Test in Canada? Why?

    The Office of the Superintendent of Financial Institutions (OSFI) requires all federally regulated financial institutions (FRFI) in Canada to qualify potential borrowers using the mortgage stress test. The mortgage stress test ensures you are not over-leveraged and can afford mortgage payments, testing your capacity to handle your current and future scheduled repayment if mortgage rates should increase. 

    Why is the Canadian Stress Test Important? 

    The mortgage stress test acts as a safeguard for both the borrower and the lender. For borrowers, it ensures that you are not overextending yourself financially by taking on more debt than you can handle if rates should increase. Qualifying for a mortgage at a rate higher than your contract rate ensures you can comfortably afford your mortgage payments throughout your term. 

    The stress test minimizes the risk of a borrower defaulting on a mortgage. Using this test to assess your ability to withstand higher interest rates gives the lender an additional layer of protection and confidence in your ability to repay your mortgage.

    What is the Stress Test for a High-Ratio Mortgage?

    To qualify for a high-ratio mortgage, you must qualify based on either the contract rate (the rate you are offered for the mortgage) plus 2% or the minimum benchmark rate set by OSFI of 5.25%, whichever is higher. 

    For example, if you are offered a 5-year fixed mortgage at a rate of 4.89%, you would add 2% to this rate, and since this is higher than 5.25%, you will be stress-tested on the rate of 6.89%. This ensures that you can still afford your mortgage payments if the next time you renew your mortgage, interest rates are higher than 4.89%. 

    5 Simple Hacks to Pass the Canadian Mortgage Stress Test

    Mortgage Stress Test Hack  #1: Improve your credit score

    Your credit score plays a crucial role in determining your mortgage eligibility and the interest rates you are offered. A higher credit score may even help you qualify for a lower interest rate, which can help you pass the stress test.

    Review your credit report regularly for errors or discrepancies in reporting to ensure these don’t impact your credit score. Dispute any mistakes promptly and ensure that all information is current. Make timely payments on all your outstanding debts, including credit cards, loans, and utilities, as these will impact your credit rating if you miss a payment. Work to lower your credit utilization ratio and pay off any outstanding balances, which will also positively impact your credit score. 

    It’s crucial to protect your credit history length by not closing out any older credit facilities. You should also consider transferring high balances on revolving debt facilities such as credit cards and lines of credit into personal loans.

    Mortgage Stress Test Hack #2: Minimize your debt-to-income ratio

    Debt service ratios are a key component in the mortgage approval process that determines your mortgage eligibility. Debt service ratios are made up of 2 key elements: gross debt service (GDS) and total debt service (TDS) ratios. GDS measures the maximum shelter costs you can afford each month, and TDS measures the total debt repayments you can afford each month. 

    To minimize debt service ratios and increase your chances of passing the stress test, start by paying off any high-interest debts you carry first, such as credit card balances. Consider consolidating your high-interest debts into a lower-interest loan or line of credit that will help reduce the interest you are paying and your overall monthly repayments.

    Another effective strategy is to increase your income to lower debt service ratios and increase your chances of passing the stress test. Look for promotion opportunities and roles that would increase your salary, or explore ways to earn extra income through side gigs, hobbies, or part-time jobs. 

    Prime lenders, which always need to stress test new mortgages, will use lower debt service ratios on higher-risk files such as those reserved for borrowers with lower credit scores. Improving your credit score gives you higher standard debt service ratios. For example, if your FICO credit score is between 650 and 679, a lender may use GDS/TDS ratios of 35/42 versus the standard ratios of 39/44 reserved for those borrowers with credit scores between 680 and 900.

    Mortgage Stress Test Hack #3: Save for a larger downpayment

    A larger downpayment reduces the amount you need to borrow and improves your chances of passing the stress test. The stress test reduces your qualifying amount, so a larger downpayment is a great way to make up this difference. 

    To get started, set a realistic savings goal and create a budget to ensure you can save consistently. Consider setting up automatic withdrawals from each paycheque into a savings account to automate your savings and keep yourself on track. You can also explore areas to cut back on, such as discretionary expenses, and reallocate those savings toward your downpayment. 

    Putting down less than 20% or greater than 35% of your property’s purchase price gives you access to the best insured or insurable mortgage rates, thus reducing your stress test qualifying rate as well. 

    There are various government programs worth exploring, such as the Home Buyers’ Plan (HBP), which allows first-time buyers to withdraw tax-free funds from a Registered Retirement Savings Plan (RRSP) to use for a downpayment. The First Home Savings Account (FHSA) is another great program allowing you to save up to $8,000 each year tax-free to purchase a home. 

    Mortgage Stress Test Hack #4: Consider a longer mortgage amortization

    A longer amortization can lower monthly mortgage payments, making it easier to pass the stress test. By choosing a longer amortization, your mortgage payments will be spread out over a longer period of time, so you’ll pay less each month toward shelter costs. This will lower your debt service ratios and increase your chances of passing the stress test.

    A longer amortization will typically come with slightly higher interest rates, and you will pay more interest over the life of the mortgage. To balance this, consider using prepayment privileges to help you pay down your mortgage faster and reduce the total amount of interest paid. You can also choose an accelerated payment frequency, which will increase your monthly payments by a small amount, help you pay down your mortgage faster and reduce interest-carrying costs. 

    Some lenders will also use lower debt service ratios when stress testing an uninsured mortgage with an amortization exceeding 25 years.

    Mortgage Stress Test Hack #5: Get a pre-approval from a lender

    A pre-approval or pre-qualification from a lender can give you a clear understanding of your borrowing capacity and a better idea of the amount you could afford when shopping for a home. A pre-approval involves a lender assessing your financial situation and creditworthiness, providing conditional approval of what mortgage amount you qualify for based on the information provided alongside a rate hold, subject to conditions. A pre-qualification will estimate your mortgage qualifying amount based on your borrowing situation and prevailing rates on your assessment day.

    This step gives you a better understanding of your purchasing power and allows you to set a budget. A pre-approval or pre-qualification does not guarantee that you will be approved for a mortgage. However, having a pre-approval letter demonstrates to sellers that you’re a serious buyer and can give you an advantage in a competitive housing market. It also allows you to shop for homes within your budget and avoid the disappointment of falling in love with a property you won’t qualify for. It also provides you peace of mind in a situation where you might make an offer on a property outside of your budget.

    3 Common Mistakes to Avoid During the Canadian Stress Test

    While knowing what to do to help you pass the stress test is extremely important, some common mistakes can hinder your chances of success and negate any of the hacks shared above. Avoid the following mistakes to ensure you’re well-prepared.

    Taking on new debt: A common mistake in the mortgage process that can hurt your ability to pass the stress test is taking on new debt. You should avoid applying for new credit cards, loans, and lines of credit during the mortgage application process. This can negatively impact your credit score and increase your debt service ratios, which could leave you unable to qualify for a mortgage.

    Making large purchases: Wait to make significant purchases, such as expensive furniture or electronics, until after your mortgage has closed and the keys to your home are in your hands. Large purchases can deplete your savings and increase your debt service ratios. If the approval was issued to you more than 30 to 45 days from the closing, the lender may need to update your credit score before sending instructions to your solicitor or notary. A large credit card purchase or consumer financing could affect your credit score.

    Neglecting your finances: This is a significant mistake when beginning the homebuying process. Stay on top of your financial responsibilities, including all bill payments (minimum payments should be automated). Ensure you’re current with tax filings and any payments due to the government affecting your public records. Late payments or outstanding tax issues can raise red flags for lenders and jeopardize your mortgage approval.

    FAQs on Canada’s Mortgage Stress Test

    What is the stress test for Canadian banks?

    The stress test for all federally regulated lenders, which includes Canadian banks, is either the benchmark rate of 5.25% or your mortgage rate +2%, whichever is higher.

    What are the stress test rules for mortgage renewals in Canada?

    The stress test rules for renewals differ depending on your situation. If you renew with the same lender, you will not be required to pass a stress test. If you have an uninsured mortgage (meaning you put down more than 20% as a downpayment) and want to switch lenders at renewal, you must pass the stress test. If you have an insured mortgage (meaning you put down less than 20% and have mortgage default insurance) and want to switch lenders at renewal, you will not be required to pass the stress test.

    Do all mortgage lenders require a stress test to get a mortgage?

    The stress test is an OSFI requirement for all federally regulated lenders. However, you may qualify for a mortgage without the stress test if you have a down payment or equity of 20% or more. You can avoid these stringent lending criteria by choosing a local credit union or an alternative lender, such as a subprime or private lender, which are not required to adhere to stress test requirements.

    Final Thoughts

    The Canadian stress test is an important way for lenders to assess your ability to repay a mortgage should interest rates rise. Factoring in a higher qualifying interest rate when a lender qualifies you for a mortgage provides them with a way to protect both parties from defaults due to rising interest rates.

    If you’re worried about passing the stress test and are in the market to purchase or renew, contact our mortgage experts today to understand how much you can qualify for.