5 Hacks to Increase Your Chances During the Canadian Stress Test
Many Canadian homebuyers encounter obstacles with elevated home prices and interest rates, making the stress test a crucial barrier to obtaining a mortgage approval. The mortgage stress test was introduced as a precautionary measure to ensure your ability to comfortably cover mortgage payments if interest rates rise.
If the stress test is causing you anxiety as a prospective homeowner, Superb Mortgages is here to assist you. This article offers five hacks that will equip you with the knowledge to ace the stress test, ensuring you confidently qualify for your dream home.
Key Takeaways
- When securing a mortgage from a federally regulated financial institution, undergoing the stress test is mandatory.
- To pass the stress test, you need to qualify either with the benchmark rate of 5.25% or your contract rate plus 2%.
- Boosting your income, increasing your downpayment, and reducing debt are vital factors that enhance your likelihood of passing the stress test.
Does Every Lender Use the Mortgage Stress Test in Canada? Reason?
All banks overseen by the Office of the Superintendent of Financial Institutions (OSFI) must use the mortgage stress test for potential borrowers in Canada. This test checks if you can comfortably handle your mortgage payments, ensuring you can handle your mortgage payments if interest rates go up in the future. It’s a way to prevent you from taking on too much debt and ensure you can manage current and future repayments.
Why is Stress Test Important in Canada?
The mortgage stress test serves as protection for both borrowers and lenders. It ensures borrowers only take on what they can handle if interest rates rise. Qualifying for a mortgage at a rate higher than your contract rate ensures you can easily manage your mortgage payments throughout the term, providing financial security.
The stress test reduces the chance of a borrower failing to repay a mortgage. By using this test to evaluate your capacity to handle higher interest rates, the lender gains an extra layer of protection and confidence in your ability to meet your mortgage obligations.
What is the Stress Test for a High-Ratio Mortgage?
To be eligible for a high-ratio mortgage, you need to qualify based on either the higher of the contract rate (the rate offered for the mortgage) plus 2% or the minimum benchmark rate set by OSFI, which is 5.25%.
For instance, if you receive a 5-year fixed mortgage offer at 4.89%, you would add 2%, resulting in a stress-tested rate of 6.89%. This approach ensures that you can manage your mortgage payments even if future interest rates upon mortgage renewal surpass 4.89%.
5 Straightforward Hacks to Pass the Canadian Mortgage Stress Test
Mortgage Stress Test Hack #1: Enhance your credit score
Your eligibility for a mortgage and the interest rates offered depend significantly on your credit score. A higher credit score also makes you eligible for a lower interest rate, aiding in successfully navigating the stress test.
Regularly check your credit report for errors or discrepancies to prevent them from affecting your credit score. If you find mistakes, dispute them promptly and ensure that all information is up to date. Timely payments on all your debts, such as utilities, credit cards, and loans, are crucial to maintaining a positive credit rating. Additionally, strive to reduce your credit utilization ratio and settle any outstanding balances, as these actions can further improve your credit score.
Preserving the length of your credit history is essential; avoid closing older credit accounts. Additionally, think about transferring high balances from revolving debt sources like lines of credit and credit cards to personal loans.
Mortgage Stress Test Hack #2: Reduce your debt-to-income ratio
Debt service ratios are vital in the mortgage approval process, deciding your eligibility. These ratios consist of two crucial elements: total debt service (TDS) and gross debt service (GDS). TDS gauges the total monthly debt repayments you can afford. At the same time, GDS assesses the maximum monthly shelter costs you can manage.
To lower debt service ratios and improve your likelihood of passing the stress test, begin by settling high-interest debts like credit card balances. Consider combining these debts into a lower-interest loan or line of credit to decrease the interest paid and your total monthly repayments.
Boosting your income is another effective strategy to decrease debt service ratios and increase your chances of passing the stress test. Seek promotions or positions that offer higher salaries, and explore opportunities to earn extra income through part-time jobs, side gigs, and hobbies.
Prime lenders, who consistently apply stress tests to new mortgages, may employ lower debt service ratios for riskier cases, especially those earmarked for borrowers with lower credit scores. Enhancing your credit score provides access to higher standard debt service ratios. For instance, if your FICO credit score falls between 650 and 679, a lender might utilize GDS/TDS ratios of 35/42, compared to the standard ratios of 39/44 reserved for borrowers with credit scores between 680 and 900.
Mortgage Stress Test Hack #3: Accumulate a more significant downpayment
Increasing your down payment decreases the borrowed amount and enhances your likelihood of passing the stress test. Since the stress test trims your qualifying amount, a larger down payment effectively compensates for this reduction.
Begin by establishing a practical savings target and crafting a budget for consistent savings. Automate your savings by setting up automatic withdrawals from each paycheck into a dedicated savings account to stay on course. Identify areas where you can trim expenses, like discretionary spending, and redirect those savings toward your down payment.
Opting for a down payment below 20% or above 35% of your property’s purchase price provides access to the most favourable insured or insurable mortgage rates. This, in turn, lowers your stress test qualifying rate.
Explore different government programs, including the Home Buyers’ Plan (HBP), enabling first-time buyers to withdraw tax-free funds from a Registered Retirement Savings Plan (RRSP) for a down payment. Another beneficial program is the First Home Savings Account (FHSA), allowing tax-free savings of up to $8,000 annually toward a home purchase.
Mortgage Stress Test Hack #4: Consider extending your mortgage amortization
Opting for a more extended amortization can reduce monthly mortgage payments, easing the process of passing the stress test. With a longer amortization, your mortgage payments are distributed over a more extended period, resulting in lower monthly expenses for shelter costs. This, in turn, decreases your debt service ratios, improving your chances of passing the stress test.
A longer amortization often means slightly higher interest rates and increased overall interest payments throughout the mortgage’s lifespan. To offset this, utilize prepayment privileges to expedite mortgage repayment and decrease the total interest paid. Opting for an accelerated payment frequency, even with a slight increase in monthly payments, can also accelerate mortgage payoff, reducing overall interest costs.
Specific lenders may apply reduced debt service ratios when stress testing an uninsured mortgage with an amortization period over 25 years.
Mortgage Stress Test Hack #5: Obtain a pre-approval from a lender
Securing a pre-approval or pre-qualification from a lender provides a transparent view of your borrowing capacity. It helps you gauge the affordable range while house hunting. A pre-approval entails the lender evaluating your financial status and creditworthiness, granting conditional approval for a specific mortgage amount with a rate hold contingent on certain conditions. On the other hand, a pre-qualification estimates your qualifying mortgage amount based on your borrowing circumstances and prevailing rates during your assessment.
This step provides insight into your buying capacity and helps you set a budget. While a pre-qualification or pre-approval doesn’t guarantee mortgage approval, a pre-approval letter signals sellers that you’re a committed buyer, offering an edge in a competitive housing market. It empowers you to explore homes within your budget, preventing the disappointment of falling for a property beyond your qualifications. Moreover, it provides peace of mind, especially when considering an offer on a property that might exceed your budget.
3 Common Errors to Avoid During the Canadian Stress Test
While understanding how to successfully navigate the stress test is crucial, certain common mistakes can impede your chances of success, undoing the benefits of the hacks mentioned earlier. Steer clear of these errors to ensure thorough preparation.
Incurring additional debt: One frequent error in the mortgage process that can hinder your success in passing the stress test is acquiring new debt. It’s advisable to refrain from applying for new lines of credit, credit cards, or loans during the mortgage application process. Doing so may adversely affect your credit score and elevate your debt service ratios, potentially reducing your chances of qualifying for a mortgage.
Making significant purchases: Hold off on making substantial purchases, like expensive electronics or furniture, until after your mortgage has been finalized and you have possession of your home. Significant expenses can diminish your savings and elevate your debt service ratios. Suppose your approval was granted more than 30 to 45 days before the closing. In that case, the lender might need to refresh your credit score before providing instructions to your solicitor or notary. A substantial consumer financing or credit card purchase might impact your credit score.
Neglecting your finances: This is a crucial error when starting the homebuying journey. Keep up with your financial obligations, including automating minimum bill payments. Ensure your tax filings are up to date, addressing any fees owed to the government that may impact your public records. Unresolved tax matters or late payments can trigger concerns for lenders and put your mortgage approval at risk.
Conclusion
The Canadian stress test is a crucial method for lenders to evaluate your capacity to repay a mortgage in the event of rising interest rates. By considering a higher qualifying interest rate during the mortgage qualification process, lenders establish a safeguard for both parties, preventing defaults caused by increasing interest rates.
If you’re concerned about passing the stress test and are in the market to purchase or renew, contact Superb Mortgages today to discover how much you can qualify for.
ownload and complete Form T1036 (Home Buyers’ Plan (HBP) Request to Withdraw Funds from an RRSP) to start the Home Buyers’ Plan application process. You should fill out Area 1, while the financial institution overseeing your RRSP will complete Area 2.
Following your request, your selected RRSP provider will transfer the funds into your designated account. Simultaneously, the financial institution overseeing your RRSP will issue a T4RSP slip verifying the withdrawn amount. This slip becomes a crucial supporting document for your tax return in the upcoming year.
More Information for Home Buyers
Other national programs for first-time homebuyers include:
- Home Buyer’s tax credit. Qualified first-time home buyers are eligible for a $10,000 non-refundable income tax credit.
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- GST/HST New Housing Rebate. Home buyers eligible for the benefit can recoup a portion of the GST or the federal component of the HST paid on a newly constructed home.
- First-Time Home Buyer Incentive. The government grants eligible home buyers a tax-free loan, constituting 5% or 10% of the purchase price of a qualifying property.
Boost your home-buying budget by incorporating the Home Buyers Plan with the First Home Savings Account. Keep in mind that executing this strategy may require patience, as you can only deposit $8,000 annually into your FHSA.
If you intend to make use of both programs, refrain from touching your RRSP to ensure it continues generating returns while giving your FHSA savings the chance to grow.