To put this into perspective, here’s what the situation would look like for a borrower who opts for a floating rate on a $700,000 mortgage, under the stress test rules:
Contract RateStress RateInterest Rate (5-Year Variable)1.50%5.25%Monthly Mortgage Payment $2,798$4,171 Interest Component of Payment $872$3,030Percentage of Interest Paid Each Month31.2%72.6%Mortgage Balance Paid After Two Years$46,886$28,814
In this example, the borrower was eligible for a monthly payment of $4,171 (at a stress test rate of 5.25%), even though their actual monthly payment was only $2,798 (at the contract rate of 1.5%). This created a payment differential or buffer of $1,373 per month – a safety net of $16,481 per year, determined by the stress test.
A prudent borrower would use this amount as forced savings or use it to speed up the mortgage payment.
What’s even more appealing is the difference in interest component between the contract rate and the stress test interest payments in the chart above. At low rates and a depreciation over 25 years, when using the contract interest rate (68.8%) a higher part of the monthly mortgage repayment consists of principal than when using the stress test rate (where the principal amounts to 27.4%).
In other words, the stress test provides an interest expense buffer of $25,887 per year ($2,157.25 per month) between the contract rate actually paid and the qualifying rate for the stress test. This would allow a borrower to further pay off their mortgage debt by increasing their monthly payment above the minimum obligation.
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Will the Mortgage Stress Test Make Up for Its Reputation?
In a low interest rate environment where the appetite for home ownership is insatiable, a tool like the mortgage stress test will shock the market. There is no doubt that it will be viewed as restrictive and unfair by many potential owners and industrial service providers.
In retrospect, however, the stress test was a good policy and of great value for housing construction. It has provided comfort to homeowners and stability for lenders and insurers against the prospect of rising rates, and it has helped the government, which insures high-ratio mortgages through the Canada Mortgage and Housing Corporation, minimize default.
The stress test has also provided an opportunity for those who want to build wealth faster. I encourage my clients who can do that to pay off their mortgage principal with the payment privileges allowed in their mortgage contract, because the stress test rate confirms that they can do so comfortably.
This post Why the Mortgage Stress Test Isn’t the Bad Guy It Was Called
was original published at “https://www.moneysense.ca/columns/mortgage-stress-test-column/”