Starting January 1, new mortgage lending rules will require borrowers to undergo a financial ‘stress test’ to prove they could afford their mortgage if interest rates were to increase.
Currently, buyers who provide less than 20% of their purchase price as a down payment are required to insure their mortgages. They must purchase mortgage insurance that protects their lender in case of a default. Those same borrowers are also required to undergo a so-called ‘stress test’ to determine whether they could withstand a substantial rise in interest rates.
Under the new regulations, the pool of borrowers who must be tested is expanded to include most new and refinanced mortgages. Now, before a lender can approve you for a mortgage, they will not only evaluate whether you can afford the rate that you have negotiated. They will also assess whether you could afford to pay 2% more than your negotiated rate or the five-year national average interest rate, whichever is greater. Essentially, this means you must be financially prepared to pay an interest rate substantially higher than the one you negotiate with your lender. The test will not apply to mortgage renewals as long as they are with the borrower’s existing lender, and purchase agreements and pre-approvals signed before January 1 will also be exempt.
The stress test is designed to protect banks and borrowers from taking on loans they can’t afford, but it will likely also price some buyers out of the market. As many as 10% of borrowers who qualified for an uninsured mortgage between 2016 and 2017 would not have qualified under the new regulations. Such buyers will now be forced to settle for less expensive homes, postpone buying until they’ve saved up a larger down payment, or leave the market altogether.
It remains to be seen how these new regulations will affect the market overall, but if you are planning to buy a new home, you should take these factors into account.