Lower Rates Means Less Stress in the “Stress Test”

two people moving in to a new house

Starting now, Canadian mortgage seekers will find it easier to qualify for more money. That’s because the Bank of Canada has dropped its five year benchmark qualifying rate from 5.34 percent to 5.19 percent. This is the rate banks use to qualify would-be-homebuyers for a mortgage.

This is the first time the rate has dropped since September 2016. Since then the rate has only gone higher. The Bank of Canada posted rate is calculated by using the five year fixed rate at the big six commercial banks.

Why this is significant?

Since January 2018, all Canadians, insured and uninsured, shopping for a new mortgage have to pass the so called “stress test.” Previously only those with less than 20 percent down, or insured mortgages, were subjected to an affordability test. Now everyone has to prove they can pay. Formally called, guideline B-20, it was brought in as a tool to better assess if Canadians could afford rates for the long term, especially if rates were to rise.

Housing slowdown

Real estate sales have slowed and prices are lower since the stress test was implemented. As Canadians can afford to borrow less, they can’t pay more for a house they want. Expert say the B-20 guideline has done its job, by lowering prices overall. In a TD Economics report released in April, economists there state “For the most part, the B-20 rules have contributed to bringing down housing activity to a more sustainable level.  However, developments should be closely monitored.  There is certainly scope to tweak the guidelines if circumstances change and/or housing markets undershoot expectations.”

Current situation

Right now all mortgage seekers, insured and uninsured, have to show they could pay their mortgage rate at either two percentage points higher than the contract rate the commercial bank is offering or the Bank of Canada posted rate. In most cases the Central Bank’s posted rate has been higher. This means even if the bank is offering you a much lower rate that you can easily afford, you still have to show you could afford the money you’re borrowing at a higher rate. It is also a way to reign in emotional purchases where you may not be considering all the factors.

How much more can you get?

The Bank of Canada’s rate is calculated by using the most frequently occurring five year fixed posted rates at the Canada’s biggest banks. Since bond yields have been falling commercial bank have been able to offer their customers lower fixed rates.  The lower rate means Canadians will be able to borrow more. For example with 20 percent down and for someone making $50,000 a year they can now afford $4,000 more. It’s even better for higher earners. For example someone with an annual salary of $100,000 can now buy a house that is $8,300 more expensive than previously. This may not seem like a huge amount, especially in markets like Toronto and Vancouver, but outside of these pricey cities it can mean the difference between winning a bidding war or losing it.

Do your own stress test

Regardless of being able to qualify for more, mortgage seekers should only borrow what they know they can afford.

For example the bank will not take into account any family obligations you have, like sending money to an ailing relative. Also, it will not consider that you enjoy taking a big family vacation every year that costs thousands or that you have an expensive hobby like golf. It only looks at your salary, your debts and your ability to pay.

Step one is to use a mortgage affordability calculator. After that, it’s up to you to decide how your money will be spent in the years you’re also paying down your mortgage.

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