The mortgage stress test in Canada is applied to determine whether homebuyers can afford their mortgage payments under higher interest rates than the actual rate being offered by the lender. This test is a key requirement for both insured and uninsured mortgages. Here’s how the stress test is applied:
Gross Debt Service (GDS) and Total Debt Service (TDS) Ratios
Qualifying Rate
The stress test requires borrowers to qualify at a higher interest rate than the actual mortgage rate. For insured mortgages (those with less than a 20% down payment), the qualifying rate is the higher of the mortgage contract rate plus 2% or the Bank of Canada’s five-year benchmark rate. For uninsured mortgages (those with a 20% or more down payment), the qualifying rate is the higher of the lender’s rate plus 2% or the Bank of Canada’s five-year benchmark rate.
Gross Debt Service (GDS) and Total Debt Service (TDS) Ratios
Lenders calculate the GDS and TDS ratios to determine if borrowers can afford the mortgage. The GDS ratio is the percentage of the borrower’s income that would go towards housing costs (mortgage payments, property taxes, heating, and half of condo fees, if applicable). The TDS ratio includes all debt payments (housing costs plus other debts). Under the stress test, these ratios are calculated using the higher qualifying rate.
Application to All Borrowers
The stress test applies to all borrowers, regardless of the size of their down payment. This includes those renewing or refinancing their mortgage, though there are some exceptions, particularly if they stay with their current lender.
Lender Compliance
Federally regulated lenders, such as banks, are required to apply the stress test to all mortgage applications. Credit unions and other provincially regulated lenders may have different policies, but many have voluntarily adopted similar practices.
Impact on Borrowing Capacity
The stress test effectively reduces the amount that individuals can borrow since it assesses their ability to pay at a higher interest rate. Since mortgages across Canada (with the exception of Alberta) are recourse loans (a recourse loan allows a lender to pursue additional assets when a borrower defaults on a loan if the debt’s balance surpasses the collateral’s value), they protect lenders by mitigating risk and the financial system at large. The stress test also makes homes more unaffordable and out of reach for the majority of Canadians, as borrowers need to adjust their expectations regarding the size of the mortgage they can qualify for or the price of the home they can afford.
Regular Updates
The stress test criteria and the Bank of Canada’s benchmark rate are subject to change based on economic conditions and regulatory decisions. Borrowers should stay informed about the current requirements.
The most recent change regarding the mortgage stress test in Canada, effective November 21, 2024, involves the removal of the stress test requirement for uninsured mortgage renewals when homeowners switch lenders. This policy change, announced by the Office of the Superintendent of Financial Institutions (OSFI), allows borrowers with uninsured mortgages (typically those with more than 20% down payment) to switch to a new lender upon renewal without needing to re-qualify under the stress test conditions. This change aims to enhance competition among lenders and provide homeowners with greater flexibility and potentially better rates when renewing their mortgages​
Before this update, all borrowers switching lenders at mortgage renewal were required to pass the stress test, which could restrict their ability to secure more favourable rates from new lenders. This adjustment is intended to balance the treatment of insured and uninsured borrowers and encourage a more competitive mortgage lending environment​
Summary
The stress test is designed to ensure that Canadians are taking on mortgages they can afford even if interest rates rise, protecting both consumers and the broader financial system. It encourages prudent borrowing and lending practices and contributes to the long-term stability of the housing market.
