Mortgage Eligibility: The Stress Test' Is For Everyone. And It's Complex
Wednesday Mar 07th, 2018
As of January 1st, every borrower needs to pass a new “Mortgage Stress Test” (MST) to qualify for a mortgage loan at a bank. And it won’t matter how much downpayment you have. Even if it’s 20% or over, you’ll still be subject to the MST. Once you pass the test, you’re not required to actually make a 20% down payment - you can still take advantage of a lower one and a lower mortgage rate. But first you have to pass 'the test'.
BREAKING IT DOWN
If and/or when interest rates increase, the Government wants you to prove you can afford payments at an interest rate higher than the actual rate in your mortgage contract.
The MST has been typically applied to insured mortgages, in which the borrower had paid less than a 20% down payment, but now it's for every mortgage.
Guess what? Credit unions are not bound by these new rules, but that may change as, they've followed the banks, in the past.
The main effect will be felt by 1st time buyers because, no matter how much money anyone puts down, they still have to pass this stress test.
WHAT ARE THE NEW QUALIFYING RATES?
The current qualifying rate for uninsured mortgages (ie: with 20% or more down) is either the Bank of Canada’s present 5-year fixed rate of 5.14% OR 200 basis points above your contractual mortgage rate. So, if you’ve been awarded a 3.45% mortgage rate, you now have to ‘qualify’ for a 5.45% one. If it's 3.2% your qualifying rate is 5.2%. If you've received a 2.1% qualifying rate, even though adding 200 basis points is only 4.1%, you'll be required to qualify for the posted rate of 5.14%.
THERE'S EVEN MORE TO THE MST.
To lenders, affordability translates into two things: Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS). They use these 2 mortgage formulas to determine exactly how much money they are willing to lend you.
The maximum GDS ratio, you can have is 39%, and TDS is 44%. (Note: while the guidelines state your GDS should be no more than 32% and your TDS should be no more than 40%, most borrowers with good credit and a reliable income will be allowed to exceed these guidelines.
What is Gross Debt Service (GDS)?
A GDS ratio is the percentage of your income needed to pay all of your monthly housing costs, including mortgage payments of principal, interest, taxes, utilities, and real estate taxes.
You’ll also need to include 50% of your condo maintenance fees, if applicable. Your GDS has to be 39% or lower to qualify for the mortgage.
To calculate your GDS ratio, you’ll need to add all of your monthly housing-related costs and divide it by your gross monthly income. Then multiply that sum by 100 and you’ll have your GDS ratio.
What is Total Debt Service (TDS)?
Your TDS ratio is the percentage of your income needed to cover all of your debts. The debt ratio formula calculation is the same as for your GDS, except all of your monthly debts are taken into consideration. This includes car payments, credit cards, alimony, and any loans.
To calculate your TDS ratio, add all of your monthly debts and divide that figure by your gross monthly income. Then multiply that sum by 100 and you’ll have your TDS ratio.
Your GDS and TDS ratios allow lenders to know if your income will cover the cost of your mortgage. If your GDS & TDS are higher than 39% and 44%, respectively, try and lower your debt before seeking out an 'alternative' lender. Those alternative (also known as 'shadow' lenders) will have higher interest rates plus higher loan fees. No lender is judging whether or not you deserve a home. They're looking at you as a potential risk and calculating that they can collect the money you’ll owe them. Over the long-term.
In addition to the GDS and TDS, there are other basic expenses like transportation and food. So you want the ratios to be as low as possible to account for these other costs.
WHAT CAN YOU DO TO LOWER YOUR GDS/TDS RATIOS?
- TDS/GDS: Make a greater down-payment, which decreases your mortgage debt and monthly mortgage costs.
- TDS/GDS: Increase your (gross) household income.
- TDS only : Reduce your current debt obligations (such as car payments, credit card interest, pay down/off credit cards.)
WHAT IF WE'RE REFINANCING?
If, on renewal, you stay with your existing lender, then you don’t have to pass the MST again. However, if you change lenders at mortgage renewal time, you may very wekk have to qualify and pass it. Lenders are thrilled about one thing: customer retention. As many as one in six people, renewing their mortgage, could be trapped at their existing bank because they can't pass the new stress test at another lender. And if a bank knows you can't leave, it may very well offer sub-par rates.