For a more secure future, stress test your mortgage today
The good news? Mortgage interest rates are still at historical lows. But as policy-makers and the media regularly remind us, this means there is only one direction for them to move – and that is up. And this could potentially mean trouble for Canadians who have stretched their budget to own a home.
Rather than worrying about what might happen and when, stress test your mortgage, urges Dilys D’Cruz, vice-president of community banking at Meridian Credit Union in Ontario.
To make it easy, Meridian offers a suite of easy-to-use online calculators, she notes. “You key in the amount of your mortgage [or the mortgage you need], at the current interest rate, and get an estimate of your payment. Then, to stress test it, you re-enter the same amount with a rate at least two per cent higher.”
“You want to make sure that if a life event means you have additional expenses or your income drops, you have a safety net.”
For Canadians in the market for a home today, recent legislation requires that any insured mortgage be stress tested as a condition of qualifying. Even if their actual mortgage rate will be much lower, borrowers must prove they’re capable of making the higher monthly payment required at the bank rate, which is currently 4.64 per cent. In the case of a $300,000 mortgage at 2.69 per cent, Meridian’s current five-year rate, that difference is $300 per month, Ms. D’Cruz points out.
But there are good reasons to do this exercise beyond the legislative requirement, even in the absence of rate increase expectations, because stress testing your mortgage is really about stress testing your life, says Ms. D’Cruz. “You want to make sure that if a life event means you have additional expenses or your income drops, you have a safety net. You’re not stretched to the max.”
For those shopping for a home or coming up to a mortgage renewal, doing the calculations online should be viewed just as an illuminating first step, she notes. “You want to sit down with an adviser who can offer solutions and options.”
While it’s easy to forget in the excitement of a home search, these are decisions that affect every aspect of your life. “Take a hard look at your financial picture and cash flow,” advises Sheila Walkington, chief financial officer and co-founder of Money Coaches Canada. “Know your numbers. What is your lifestyle costing you now? What are you willing to adjust to be sure you can afford the additional costs that come with home ownership?”
Buying a home without reducing other spending can mean running up credit cards or a line of credit quickly, she says. To avoid that outcome, she recommends setting up an automatic savings plan for all the things you’ll want and need going forward, including other important priorities such your children’s education, a comfortable retirement and vacations. “Put a plan in place to ensure you can live well now and are prepared for the future. If that feels daunting, find the support you need.”
As with any major commitment, it’s best to think through all possible outcomes, says Brandon Scott of Benchmark Mortgages Inc. in Edmonton. “Getting married and getting a mortgage have more in common than you may think – it’s important to realize the honeymoon phase may wear off.”
The federal government has made six major policy changes in the last eight years that impact mortgage options for Canadians, so it’s critical to seek expert advice, he adds. “For instance, someone who owns their own business may have a tougher time today than a few years ago.”
While self-employed Canadians naturally want to claim all deductible business expenses to reduce their taxable income, this may not be the best strategy when seeking a home loan or refinancing.
“Connecting your mortgage professional and your tax adviser early will ensure you are declaring enough income to meet current guidelines.”
Stress testing a mortgage should also include considering some ‘what-if’ scenarios, Mr. Scott notes. “Make an exit plan for situations such as a job transfer or selling the home for less than it cost. When you consider terms, conditions, privileges and penalties, a mortgage that appears to have a lower rate may, in fact, cost more in the long run.”
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