Tips to pass the mortgage stress test as interest rates rise

As interest rates continue to rise, it’s getting harder and harder for Canadians to buy a home — especially when you have to pass the mortgage stress test.

The test, which first came into effect in 2018, requires all home buyers to prove they can afford to make payments on a mortgage at their contract rate plus two per cent, or a total rate of 5.25 per cent, whichever is higher. That means many borrowers must prove they can afford a mortgage at a whopping seven per cent rate — too high for many.

So, what to do if you want to purchase a home and want to get around — or ahead — of the stress test?

Jason Heath, a certified financial planner at Objective Financial Partners, says buyers can consider variable rate mortgages.

“The stress test numbers tend to come back a little bit better for variable rate mortgages,” says Heath. The latest interest rate hike puts the stress test for most variable-rate borrowers at around six per cent and as high as seven per cent for fixed-rate borrowers.

According to Heath, you have to meet a lower stress test rate with a variable rate mortgage because it’s almost like you’re buying an insurance policy against interest rates rising — for the lender. Variable rate mortgages are pegged to your bank’s prime rate. As the Bank of Canada hikes interest rates, the prime rate increases, and so does the interest rate on your variable-rate mortgage.

But there are some potentially serious downsides to going this route.

“It’s almost like a short-term fix because if you’re not going to be able to comfortably pay your mortgage at higher interest rates, you may face challenges if and when interest rates move higher,” says Heath. The central bank has signalled more hikes are on the way.

Jordann Brown, at Canadian real estate marketplace Zolo, says tough as it is, buyers should focus on increasing their income, increasing the size of their down payment and paying down their debt, rather than attempting to circumvent the stress test.

These three strategies, according to Brown, will improve your gross and total debt service ratios and your ability to afford your mortgage.

“Whenever it comes to borrowing for a big purchase like a home, any cuts that you make to borrow a tiny bit more or qualify for a higher mortgage might just be indicative of the fact that you’re borrowing too much in the first place,” says Heath.

By doing so, he adds, you might be setting yourself up for other risks in the future, such as not having enough saved for retirement or not having cash on hand for repairs and emergencies.

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