How To Pass The Stress Test

First things first: even though it is generally better if you CAN pass the stress test, you don’t necessarily need to pass the stress test if any of the following are true:

1. You are refinancing your home.

2. If you are purchasing a home and you have a down payment greater than 20%.

3. You are getting a private mortgage.

If you do not fall into any of the above categories, for example you are buying a home with the minimum down payment, you will need to pass the stress test. What does that mean? It used to mean that you could afford the payments on a mortgage at 5.25% amortized over 25 years. Nowadays, with the higher interest rates, it means that you need to be able to afford the payments on a mortgage at the contract rate + 2%, amortized over 25 years. (It’s important to mention the amortization because when you extend the amortization, the payments become more affordable.)

What is the contract rate? The contract rate is the rate the bank is giving you. For example, let’s say the bank is offering you a rate of 4.5% on a 5 year fixed term. That means the stress test rates will be 6.5%. So you would need to prove to the bank that less than 39% of your gross annual income would cover the mortgage payments at 6.5%, the property taxes, and the hearing costs. If it takes more than 39% of your gross annual income to do that, then you fail the stress test and you will not be approved.

One trick you can use to help pass the stress test is by taking a variable rate mortgage which is generally lower than the fixed. Add 2% to the variable and you arrive at a lower rate that is easier to pass. However, this approach is a little precarious because if the prime rate goes up prior to closing, you might qualify for less!