Getting approved for a mortgage isn’t as easy as it used to be. As an accountant, making sure your clients are prepared for a mortgage stress test eases their minds and is one more value-added service you can provide.
Before the inception of the mortgage stress test, analysts predicted that it would make obtaining mortgages much more difficult. The Office of the Superintendent of Financial Institutions (OSFI) stated that the intention is to reduce foreclosures and the inability to pay. So, how can you prepare your clients for a mortgage rate stress test?
How the Mortgage Stress Test Works
In the mortgage stress test, loan officers reviewing applications consider whether borrowers can afford a higher interest rate. In particular, they look at the higher of the five-year benchmark rate or the borrower’s approved rate plus two points.
For example, someone taking out a mortgage with a 4% interest rate must afford a 6% interestrate. In contrast, someone with a mortgage with a 2% interest rate must qualify for a mortgage with a 4% interest rate. If the ending rate (in this instance, 4%) is lower than the benchmark rate (currently 4.9%), the applicant must meet that requirement. If borrowers don’t meet at least the benchmark rate, they don’t qualify.
In addition to passing the stress test, your client must also meet other criteria when taking out a mortgage. Clients can only spend a maximum of 32% of their total income on housing costs, which means that the mortgage plus utilities and property taxes cannot exceed 32% of their total income.
Your client’s total debt-to-income ratio can’t be more than 44%. That ratio divides their housing payments, car payments, credit card payments, and any other debts by their income. Crunch the numbers for your clients or help them with the calculations before they apply. With proper guidance from you, your client can still obtain a mortgage.
Who Is Affected by the Mortgage Stress Test?
The mortgage stress test only applies to borrowers who have at least a 20% down payment. The test brings that group’s requirements in line with the requirements in place for other borrowers. For example, if someone buying a $300,000 house has $60,000 or more for the down payment, they have to pass the stress test. If their down payment is smaller, the existing set of rules applies.
The test only affects people taking out loans from federally regulated lenders. If your client is buying a home with owner financing or has financing through a credit union, the stress test doesn’t apply. A client who wants to refinance a mortgage must pass the stress test to work with a new lender, but if they stay with their existing lender, that lender gets to decide whether to apply the stress test.
Areas Most Affected by the Stress Test Legislation
Analysts from the Bank of Canada estimate that $15 billion in mortgage loans would not have been funded had the stress test gone into effect sooner. Roughly 10 billion of these loans were based in Toronto and Vancouver. As time passed, British Columbia has also proven to be an area greatly affected by the stress test.
Home builders are also significantly affected by the mortgage stress test. As home sales have gone down, so has the hiring of builders to build new homes. The demand for home building has decreased compared to the time when more people qualified for home loans. The number of home sales in places such as British Columbia has gone down greatly, leading some analysts to believe the stress test’s two-point spread should be reduced or that the stress test legislation should be repealed.
The Purpose of the Stress Test
The purpose of any stress test is to see how something functions under stress. The mortgage stress test makes sure borrowers can withstand the stress of an interest increase. Indirectly, the test also determines if borrowers can cover their mortgage payments if they incur unexpected bills or experience an income reduction. While the mortgage stress test was created to reduce missed payments and foreclosures, it has had a broader effect. In areas such as Toronto and Vancouver, the stress test has reduced demand for mortgages by weeding out certain borrowers. Effectively, the stress test reduces borrowers’ buying capacity by about 18.5%. If a buyer was approved for a $400,000 mortgage under the old rules, they only qualify for a $326,000 mortgage under the mortgage rate stress test. In some cases, the reduction in buying power is even higher, depending on the current benchmark rate and the interest rate offered with the loan.
Buying a home is a joyous occasion for most people. If you have clients who are anticipating a tax refund, they may want to put that money toward a down payment on their own home or an investment property. As a professional, you can help your clients navigate the mortgage rate stress test. Talk with your clients before they apply so they know what to expect.
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