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The STRESS test… Should you be stressed?

19 Dec The STRESS test… Should you be stressed?

Posted at 10:46h in Blog by

The Office of the Superintendent of Financial Institutions (OSFI) has introduced new mortgage regulations set to take effect on January 1, 2018. Many home buyers have been anxiously rushing to purchase a home before the deadline. While this may be necessary for some buyers for affordability reasons, most buyers are already tested under the “new” regulations.

Both the government and citizens are worried about real estate market conditions for the following reasons:

  • Interest rates have been at a historic low for a record number of years. What will happen to mortgage holders when interest rates begin to rise?
  • Real estate prices are at an all-time high, specifically in the Greater Toronto and Greater Vancouver areas. This has led to record levels of debt.

What exactly is the STRESS test?

The purpose of the test is to address the fears of mortgage holders about what will happen when interest rates being to rise. Mortgage lenders need to ensure that if interest rates were to increase by 1–2%, their clients will still be able to keep up with their payments and maintain their lifestyle.

How does it work?

Suppose you purchase a home with less than 20% down payment, also known as INSURED FINANCING:

  • 2017 – Your income-to-debt ratio is serviced at 4.99% on a 25-year amortization. Even though your interest rate will be much lower (e.g., 2.25%), you can technically afford to maintain your lifestyle at a 4.99% mortgage rate.
  • As of January 1, 2018 – Your income-to-debt ratio is serviced at 4.99% on a 25-year amortization OR your given interest rate + 2%, whichever is higher. For example, if you receive a 5-year fixed rate at 3.39%, your debt is serviced at 5.39%.

Suppose you purchase a home with more than 20% down payment, also known as CONVENTIONAL FINANCING:

  • 2017 – Option A – You choose a 5-year fixed rate of interest. Your debt is serviced at the rate you receive (e.g., 3.19%), up to a 30-year amortization. If interest rates rise, you may not be able to “technically” afford the home you purchased; however, you are protected for 5 years.
  • 2017 – Option B – You choose a 1- to 4-year fixed rate of interest OR a variable rate. Your debt is serviced at 4.99%.
  • As of January 1, 2018 – Your income-to-debt ratio is serviced at 4.99% up to a 30-year amortization OR your given interest rate + 2%, whichever is higher. For example, if you receive a 4-year fixed rate at 3.19%, your debt is serviced at 5.19%.

What changed?

Everyone now qualifies for financing on the same playing field, regardless of what interest rate you choose.

What does all of this mean for me?

This new financing requirement is important when interest rates are rising. Home buyers need to feel secure that the home they are purchasing is within their budget.

For example, let’s compare qualification for a 2017, 5-year fixed rate vs a 2018, 5-year fixed rate for qualification:

  • The client earns $100,000, has $0 in unsecured debts and is putting 20% down on a condominium. His purchase price qualification DECREASED from $725,000 down to $550,000. This is a 24% decrease in purchasing power.