What is the Mortgage Qualifying Rate (Stress Test)?
The Mortgage Qualifying Rate (MQR), commonly referred to as the "stress test," is a crucial aspect of the Canadian mortgage approval process. Introduced by the Office of the Superintendent of Financial Institutions (OSFI) and the Bank of Canada, the stress test ensures that borrowers can afford their mortgage payments even if interest rates rise in the future.
Purpose of the Stress Test
The primary purpose of the stress test is to:
Protect Borrowers: By assessing the borrower's ability to manage higher payments, the stress test helps prevent financial strain if interest rates increase.
Stabilize the Housing Market: It aims to maintain stability in the housing market by avoiding scenarios where a large number of borrowers default on their loans due to rising interest rates.
Promote Responsible Lending: Lenders are encouraged to adopt prudent lending practices, ensuring that borrowers do not take on more debt than they can handle.
How the Stress Test Works
When applying for a mortgage in Canada, borrowers are required to qualify at a higher interest rate than the actual rate offered by the lender. This higher rate is the stress test rate. The stress test rate is determined as the higher of:
The Bank of Canada's five-year benchmark qualifying rate.
The mortgage interest rate offered by the lender plus 2%.
Example of the Stress Test Calculation
Suppose you are applying for a mortgage with an offered interest rate of 5%. To determine your eligibility, the lender will use the higher of the two rates:
Bank of Canada's five-year benchmark qualifying rate (e.g., 5.25%).
Offered rate plus 2% (5% + 2% = 7%).
In this case, since your contract rate + 2% is higher than the benchmark qualifying rate (5.25%), the lender will use 7% to assess your ability to afford the mortgage.
Impact on Borrowers
The stress test can affect borrowers in several ways:
Reduced Purchasing Power: Some borrowers may qualify for a smaller mortgage than anticipated, affecting the price range of homes they can consider.
Higher Savings Requirements: Borrowers may need to save a larger down payment to afford the desired home.
Improved Financial Stability: The stress test contributes to long-term financial stability by ensuring that borrowers can handle higher payments.
Exemptions from the Stress Test
Certain mortgage products and situations are exempt from the stress test, including:
Renewals with the same lender, provided there are no changes to the mortgage terms.
Some types of mortgage products, such as private mortgages, might not be subject to the same rules.
Tips for Passing the Stress Test
Improve Your Credit Score: A higher credit score can lead to better mortgage rates and improved approval chances.
Increase Your Down Payment: A larger down payment can reduce the loan amount needed, making it easier to qualify.
Reduce Other Debts: Lowering your overall debt load can improve your debt-to-income ratio, a key factor in mortgage approval.
Consider a Longer Amortization: A longer amortization period can lower monthly payments, helping you meet the stress test criteria.
Conclusion
The Mortgage Qualifying Rate (stress test) is a vital part of Canada's mortgage lending framework, designed to ensure that borrowers can manage their mortgage payments even if interest rates rise. By understanding how the stress test works and taking steps to improve your financial profile, you can better navigate the mortgage approval process and secure the home of your dreams responsibly.