Area of Law: Real Estate Law
Answer # 408
What mortgage loan amount can you qualify for? Stress TestRegion: Ontario Answer # 408
When buying a home, the generally accepted practice is that the purchaser spends no more than 25% of their gross monthly income on principal, interest and taxes. Financial institutions use established formulas to calculate the exact amount of a mortgage loan they think you can reasonably handle, taking into account your existing debts and the various other expenses that are involved in owning a home.
The two most commonly used financial formulas are:
- Gross Debt Service (GDS) ratio: the percentage of gross income (before deductions such as income tax) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating; and
- Total Debt Service (TDS) ratio: the percentage of gross income (before deductions such as income tax) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating, plus other debts, such as credit card payments, car payments or lines of credit.
Mortgage Rate Stress Test
In January 2018, the Government of Canada’s Office of the Superintendent of Financial Institutions (OSFI) amended the mortgage rules introduced in 2016 that require Canadian home buyers to take a mortgage stress test to qualify for a mortgage at a bank. Previously, this test was only required to approve buyers who had a down payment of less than 20% and required mortgage loan insurance. Now all buyers, including those with a down payment greater than 20% who do not require the default loan insurance must take a mortgage stress test.
The stress test is applied at the time of the mortgage loan insurance application. It is conducted to ensure that the home buyer could still afford the mortgage if interest rates were to rise.
Requirements for home buyers to pass the mortgage rate stress test are as follows:
Insured (those with less than a 20% down payment – need mortgage insurance)
- In addition to qualifying for a loan at the negotiated rate in the mortgage contract, the home buyer also needs to qualify at the Bank of Canada’s five-year fixed posted mortgage rate.
Uninsured (those with over a 20% down payment – do not need mortgage insurance)
- In addition to qualifying for a loan at the negotiated rate in the mortgage contract, the home buyer also needs to qualify at the Bank of Canada’s five-year fixed posted mortgage rate, or, an increase in their current rate of 2%, whichever is greater.
As well, both insured and uninsured buyers:
- cannot be spending more than 39% of income on home-carrying costs (GDP) like mortgage payments, heat and taxes. (CMHC normally restricts its GDS ratio to 35%, however, borrowers with reliable income and good credit may be allowed to exceed these guidelines up-to the maximum 39%); and
- the home buyer’s TDS ratio must not exceed 44%. (CMHC normally restricts its TDS ratio to 42%, however, borrowers with reliable income and good credit may be allowed to exceed these guidelines up-to the maximum 44%)
Mortgage lenders will use these ratios to determine the maximum amount they will lend you. The new mortgage stress test does not apply to grandfathered loans, which are any of the following:
- loans made before October 17, 2016, and their renewals,
- mortgage loan insurance applications received before October 17, 2016,
- where the lender made a legally binding commitment to make the loan before October 17, 2016; or
- the borrower entered into a legally binding agreement of purchase and sale for the property against which the loan was secured before October 17, 2016.
The new stress test does not apply to mortgage renewals, as long as they are with the borrower’s existing lender.
Federally regulated Canadian banks must establish loan to value (LTV) limits that are in line with the stress test and take risk into consideration. These LTVs are to be updated by the banks to reflect changes in the housing market and the economic environment.
Loans through other lenders:
Further, banks are prohibited from arranging loans through other lenders for residential mortgages, where the loan is not within the LTV limit. The restriction only applies to new transactions and does not apply in cases where the other lender providing the secured funding is municipal, territorial or provincial, or the federal government.
For more information, visit the Office of the Superintendent of Financial Institutions (OSFI), or CMHC, Canada Mortgage and Housing Corporation, a government owned institution that is the main provider of housing and mortgage insurance information in Canada.
If you are buying a home and want to know how much of a mortgage you qualify for, use the Scotiabank mortgage calculator .
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