We expect the best every day: We carry umbrellas when it’s cloudy, pop Gravols before a long flight, and buy travel insurance when going overseas. We don’t take on mortgages without doing a similar type of preparation! A mortgage stress test is a good way of preparing yourself for a potentially bad situation. This blog post will help shed light on how this test works.
Everything You Need to Know About a Mortgage Stress Test
The stress test is used to determine the maximum amount of money that you can afford to borrow. It is calculated by looking at how much your mortgage payments will increase (relative to the present interest rate) if you have a higher interest rate for a set period of time. The set period is either 2 or 3 years, depending on the lender.
Why do I need a stress test?
The stress test ensures that you have enough money to comfortably pay off your mortgage, even when rates increase. It is a way for the bank to ensure that you will have enough money left over after paying your mortgage.
How does a stress test work?
When you apply for a mortgage, the bank or lender will find the maximum amount that you can afford to pay after a certain period. This is the maximum amount that you can afford to borrow. They then calculate how much money you would need to have on hand if interest rates increased by a certain percentage (~ 2-3%). They then use the greater of these two figures to determine the amount you can borrow.
How to stress-test your mortgage
There are two different types of mortgage stress tests – an interest rate stress test and a credit stress test.
Interest Rate Stress Test
The interest rate stress test is used specifically to show that you can afford your mortgage if interest rates increase by a certain amount. This is a mandatory test for all borrowers who apply for a mortgage. The test uses a common mortgage stress test formula, where the mortgage rate is multiplied by the amount that you borrowed and then divided by the purchase price of your home.
Credit Stress Test
The credit stress test is used to show the lender that you can still pay off a mortgage if interest rates increase, even if you have a bad credit score. This test is not mandatory, and only some lenders require it. This test is also used to assess your ability to pay off your mortgage if interest rates increase and your credit score decreases.
Conclusion
The stress test is used to determine whether you can afford your mortgage in the case of an interest rate increase. It is mandatory for all mortgage loans. If the lender does not perform a stress test, the risk of default increases. You can do your own test by using an online mortgage calculator. If you have further questions about the stress test or about taking out a mortgage in general, seeking advice from a mortgage agent is the right way to go.
If you are a first-time home buyer in Ottawa, contact Ottawa Mortgage Services. We provide mortgage agent services for first-time home buyers, self-employed individuals, commercial clients. We also help with refinancing, pre-approvals, and debt consolidation.
