Insider secrets: How to pass the mortgage stress test with flying colours

As of January 1, 2018, Canada’s banking regulator changed the rules of the mortgage approval game, and it’s made financing harder for first-time and experienced home buyers alike. We sat down with Sandra Lethby, Meridian Credit Union’s mobile mortgage sales specialist, to find out what’s new, how it may affect you, and what you can do about it, with special advice for people buying a new construction home.

Q: What are the new mortgage rules? 

Sandra: Back in late 2017, the government created a “stress test” for people who had less than 20% of the purchase price as their down payment. As of January 1, 2018, that stress test now applies to every home buyer across the board, whether you have a 5% or 25% down payment, whether it’s your first home or your fifth.

Q: Why is it called a “stress test”?

Sandra: The government wants to make sure you can handle the stress of higher interest rates and still make your payments, so your application gets “tested” against a higher interest rate. Right now, the test rate is the “five-year benchmark rate”—currently at 5.14%—or 200 basis points above your mortgage rate, whichever is higher. It makes sense. We can’t keep going at these low interest rates forever. The test is there to protect Canadians, to make sure we can still afford our homes when interest rates go up. 

Q: Does everyone have to pass the stress test?

Sandra: If you go to a conventional lender, like a big bank, yes. Right now, credit unions like Meridian are exempt from this new rule because we’re provincially regulated and this is a federal rule. This is great news for buyers. It means if you can put down 20% of the purchase price as your down payment you only have to qualify at the current mortgage rate, not the higher rate. It’s a lot easier to qualify for a mortgage at 3.49%—today’s five-year mortgage rate—than the stress test rate of 5.14%.

Q: What’s a common misconception about the stress test?

Sandra: The biggest misconception is people think their monthly payments will be based on the higher qualifying rate. They’ll ask “Why am I making payments at 5.14%?” They aren’t. They’ll make payments at the current mortgage rate, which will be lower than the stress test rate. The stress test is just that: a test.

Q: Is it easier or harder to get financing on a new construction home?

Sandra: Meridian Credit Union and Phelps have a long-standing relationship. Meridian has a good level of comfort about the builder and the quality of the homes. We know the home will be priced well, the builder’s reputation is solid and the value is there. You may not even need an appraisal. A Phelps home is insured by Tarion, too, and that gives us comfort. With a resale home, especially in a really hot market where properties are selling well above list price, the value may not be there, which makes the mortgage a bigger risk for the lender.

Q: What should a new construction home buyer be aware of when it comes to financing?

Sandra: Usually rates are locked in for 120 days, but we’ve held rates for Phelps buyers for up to 18 months, with no need to go through the approval process again provided you don’t increase your financing amount. That means you’ll want to budget for your upgrades at the time you’re locking in your rates. If you come to us later and say you need another $20,000 for upgrades, we’ll need to redo your application and you may lose your guaranteed rate. You’ll also need to show us that you have the money available to cover closing costs, which can be a little higher for a new construction purchase. The city may require you to plant a tree in your front yard or you may have to pay for your gas meter as part of closing costs, which you wouldn’t have to do with a resale home.

Q: How can home buyers increase their chances of approval?

Sandra: First, see if you can get a 20% down payment together so you can avoid the stress test if you work with a credit union. I just did an application for a member who had saved for a 10% down payment while living at home and working at a good job. If he’d had to pass the stress test he wouldn’t have been able to get his foot in the door so his parents chipped in the other 10% and we approved him. Another tip is to keep your student loans with the Canadian Student Loan Centre. A lot of people will transfer their student loans to a line of credit at a lending institution, turning it into what we call an “unsecured debt” which counts against your mortgage application significantly. The last tip is to avoid maxing out your credit cards and lines of credit. Try to pay them all off in full every month. If you’re keeping a balance, make sure it’s no more than 50% of your credit limit. Ideally, you would be best to keep it at 30% of your credit limit.

Q: What is Meridian’s application process like?

Sandra: Our approval process is different from the banks. I meet with clients whenever and wherever is convenient for them and find out what they need. We don’t work with a computerized system and try to fit people into check boxes. We look at the big picture and understand people’s stories, because sometimes people don’t tick all the right boxes, but they should be approved for a mortgage. If people are just a number, they sometimes get turned down.

Q: What happens behind the scenes?

Sandra: Once I’ve done my part, the application goes to our underwriting team, who reviews the application on two fronts: the strength of the applicant, and the strength of the property. If the applicant is salaried and putting down 30% on a Phelps home, they’re strong on both the personal and property sides. If they’ve only got 5% down, they’ve had a few job changes recently and they’re buying a resale home that may be overvalued, we have to see if there’s a way we can strengthen the application.