Interest rates have been low for the better part of a decade, but just because they’re low now, it doesn’t mean they’ll stay low forever. Although it doesn’t look like the Bank of Canada is going to be raising interest rates this year, who’s to say our central bank won’t raise interest rates next year or the following year? The Bank of Canada has raised interest rates five times since mid-2017 and it could very well do it again in the future. How do you prepare your family for possible interest rates hikes? You can do that by stress testing your family’s finances.
Let’s take a closer look at stress testing and why it’s important.
The Mortgage Stress Test
When you hear the term “stress test,” probably the first thing that comes to mind is the mortgage stress test.
The mortgage stress test was introduced on January 1, 2018, to protect homeowners from rising interest rates. Anyone buying a home putting down at least 20 percent must pass the mortgage stress test. The mortgage stress test makes you qualify at a mortgage rate higher than the actual mortgage rate you’re signing up for.
The stress test requires you to qualify at the greater of your mortgage rate plus two percent and the Bank of Canada’s five-year benchmark rate (currently at 5.34 percent). For example, if you’re applying for a mortgage with a rate of 3.39 percent, you need to qualify at 5.39 percent, since 3.39 percent plus 2 percent is higher than 5.34 percent.
The mortgage stress test was mainly brought in to cool the overheated real estate markets in Toronto and Vancouver, as well as protect homeowners from higher mortgage rates when their mortgages come up for renewal. What if mortgage payments were 2 percent higher when your mortgage came up for renewal, could you handle it? That’s the all-important question the mortgage stress test answers.
Applying the Stress Test to Your Other Debts
Although the stress test is a term most often associated with mortgages, it’s a good idea to also apply it to other debt that you’re carrying, especially any debt with a variable interest rate. For any debt with a variable interest rate, you’ll feel the effects right away of an interest rate hike. If interest rates on your line of credit or personal line tied to prime rate were to rise 2 percent, could you handle the new payment? That’s the question you should be asking yourself.
Although you won’t feel the effects right away of an interest rate hike to any of your debt with a fixed interest rate, it’s still important to stress test it, as you could face a higher payment when your term ends and you need to renew.
Taking Stress Testing a Step Further
If you want to take stress testing a step further to ensure you’re prepared if and when higher interest rates arrive, you can pay your debt as if interest rates are already 2 percent higher. By doing that you won’t feel as much of a shock when interest rates eventually rise, not to mention you’ll save lots on interest by paying more than you need to at present interest rate levels.
Need some help with stress testing your own finances? Contact our offices today. Our credit consultants are happy to help.
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About the Author
Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedIn, Twitter, Facebook and Instagram.