The Code Breakers: Secrets to Clearing the Canadian Mortgage Stress Test in Today’s Toronto Market

In terms of Toronto real estate, an interesting transition is taking place. The average cost of homes is about $993,410, thus bringing some neighborhoods of Toronto to the balanced or even buyer’s market. For the buyers, it may seem like a perfect time to take the plunge. There is only one major barrier standing in your way, however: the Canadian mortgage stress test. Conducted by the Office of the Superintendent of Financial Institutions (OSFI), this mortgage stress test requires you to be qualified not at the rate your mortgage broker offers but rather at the rate that is your contracted rate plus 2% or 5.25%, whichever is higher. Given that the 3-year and 5-year fixed contract rates range between 3.8% and 4.4%, you are essentially being put through the wringer to see whether you can handle an interest rate of 6.0% to 6.4%. It takes around $201,000 of total income per year to purchase a reasonably priced home in Toronto with a 20% down payment. Should your family’s total income fall short of that figure, don’t be alarmed. The system may appear rigid, but a seasoned buyer knows how to crack the code. These are the elite, legal ways to beat the mortgage in Toronto stress test in present-day Toronto.

Strategy 1: Shift to a Credit Union (The “OSFI Loophole”)

The biggest secret in Canadian lending is that provincially-regulated credit unions do not have to stress test you according to OSFI requirements. When it comes to the large banks like Royal Bank, TD or Scotia Bank, they are all regulated by the federal government and they all have to stress-test you. The provincial credit unions such as Meridian or Duca in Ontario, are more flexible. The provincial credit unions can stress test you at your contract rate or apply a much lower stress test metric.

• Effect: The shift from one of the major banks to a credit union will automatically increase your buying power from 10% to 15% with the same income.

• The downside: Provincial credit unions may ask for a slightly higher contract rate or for a fee, which is worth paying to pass the qualification.

Strategy 2: Use the Amortization Extension

In case you are contributing a 20% down payment or even above, the general rule of thumb at banks will automatically extend your amortization period to 25 years. Nonetheless, legally, you have the opportunity to extend your amortization period to 30 years.

What does extending the amortization period do? Two things are done at once;

1. The payment made to the principal becomes smaller. 

2. As the monthly payments will be reduced, the Debt Service Ratio (GDS and TDS) decreases substantially.

As the Debt Service Ratios decrease, it makes you much safer as far as the automated system of the lending institution is concerned.

Strategy 3: Vaporize Your Revolving Consumer Debt

As lenders put you through a stress test, they do not only focus on your future mortgage in Toronto; the Total Debt Service (TDS) ratio has to be below 44% of your gross income. Buyers often overlook the influence that their consumer debt will have when buying a home. For instance, a $10,000 credit card or a car lease that costs you $400 a month could reduce your purchasing power by $40,000 or even $50,000 worth of mortgage. Before getting a pre-approval, halt your home shopping process and get rid of all your car payments, student loans, and credit card debts. It is better to have a lower down payment and no consumer debt than a higher down payment burdened with monthly payments.

Strategy 4: The Strategic Co-Signer Gift

If you are near to but below the income mark, a co-signer from your family might be the perfect solution to end the stalemate. In the cutthroat environment of Toronto, a co-signer does not just bring the emotional boost, but also their income will go towards your Gross Debt Service ratio. In addition, if you are receiving a cash gift from your family for the down payment, making sure that it brings your down payment over the 20% threshold makes CMHC mortgage default insurance unnecessary, allowing you to utilize the 30-year amortization period trick described above.

Strategy 5: Prefer 3-Year Fixed or Variable Rates

Interest on mortgages is flexible. As 5-year government bond interest rates have upward momentum, 5-year fixed bank rates continue to be rather stubborn (approximately 4.8% to 5.0%). But 3-year fixed rates (approximately 3.8% to 4.2%) and 5-year variable rates (approximately 3.3% to 3.4%) can give you a much lower starting point. This is because 2% is added to your mortgage rate by the stress test, and by having a lower mortgage rate, you automatically get a “lower ceiling” under stress test rules. 

Conclusion 

The stress test for Canada was not created with the intention of stopping you from purchasing a home; rather, it was designed to ensure that the banking system does not get into default. However, in a costly market such as Toronto, you need to approach it strategically.  Forget about going around walking into any local bank branch hoping for a different outcome. You will be able to crack the code and pass the stress test by wiping out consumer debt, using short-term fixed rates, increasing your amortization period to 30 years, or simply going against the rules and using an Ontario credit union.