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What is mortgage stress testing?
According to research, about 30 percent of first time home buyers anticipate that interest rates will stay constant for the next five years. However, one of the hazards of signing a mortgage in the Canadian market is that you have to be ready for rates to go up. In the United States, you can sign a 30-year mortgage that keeps the same rate for the entire life of the loan. However, in Canada, you cannot sign a note for longer than ten years. After that, you have to either extend your loan with the same lender or find another source of funding. The purpose of a mortgage stress test is to figure out what your future payments would be, on the basis of a potential interest rate in the future and the balance that your mortgage might have at the time of renewal. (Stress Testing Definition)
Within the mortgage industry, the guideline is that your total housing costs (mortgage payments, property taxes, utilities, association fees and so on) should not take more than a third of your overall gross income. Unless you have the resources in place, going above this level can shatter your budget, particularly if you have other significant monthly obligations, such as a high car payment. Maintaining affordability throughout the life of your loan, and at renewal, is not as difficult to accomplish as you might think. Some potential steps for maintaining affordability include the following.
1.) Lock into a longer loan term at a fixed rate
If the current interest rates are attractive to you, lock into a ten-year fixed loan. Most analysts agree that interest rates are going to be higher in the future than they are today, so the longer you lock in that good rate, the better off you are likely to be.
2.) Pay down your principal faster than your minimum payment permits
When you start paying a mortgage at the beginning, the vast majority of your payment goes toward interest, with just a pittance going toward principal. However, if you are able to pay a little extra each month, that extra amount goes right toward principal, reducing the amount you actually owe instead of just paying for the cost of the financing. You can lower your balance at renewal, giving yourself some flexibility with financing, by putting down a little bit of money each month. One way to calculate this is to select the longest amortization possible at settlement, such as 30 or 35 years. However, set your own payments to the 20- or 25-year amortization amount. You won’t officially commit to this with your bank, but you will go ahead and start making those payments. This helps you get in the habit of making a payment that will eat up that principal. If there are some months when things are tight, you can drop to your required minimum and then amp it back up the next month.
3.) Check out the “skip a payment” option
Some lenders offer this, but it is not wise to accept it unless you are in a genuine emergency. Your interest costs go up, and your amortization gets longer, putting you in more risk at renewal.
Mortgage Stress Test
If your credit is at risk, there is a way to run a “reverse mortgage stress test” in order to ensure that you can have an easier time with your mortgage over the long term. You start out with a private mortgage, with a term of a year or two, and use that time to get your credit up where it needs to be to qualify for a traditional mortgage. Get a credit coach to help you during this process, and set a budget that you can keep. This will help you get back in the right sort of habits so that you can carry a traditional mortgage — with lower rates than a private loan — in a year or two. While rates are likely to be higher then than they are now, this is a better alternative than not qualifying for a loan at all. Also, because your traditional loan will likely have a lower interest rate than the private loan you take out at first, you will have a lower payment when that new loan starts. Getting used to that new payment will be easier, because you will have already had to deal with private loan payments.
Amansad Financial has relationships with many private lenders that will help you with reverse mortgage stress testing, and the company also has professionals to help take you through your own scenario and come up with the best financing solutions.