In recent months, the housing market pendulum has swung more toward affordability for first-time home buyers than it has in several years, for two reasons. First, after years of price increases, the average cost of a home in Canada has (according to the Canadian Real Estate Association) declined by about 3.4% over the past year. At the same time, cuts made by the Bank of Canada in interest rates have resulted in lower mortgage lending costs. In July of 2023, the Bank Rate (from which all other lending rates are derived) stood at 5.25%; as of the end of October 2025, it was 2.5%. While getting into the position of being able to purchase a first home is still a formidable task, that goal is now somewhat more accessible than it has been for some time.
Before a first home can be purchased, however, buyers must qualify for a mortgage. The rules governing mortgage approvals in Canada require prospective homeowners to show both that they have accumulated a sufficient down payment and that they will be able to manage the amount of mortgage debt they are taking on, now and in the future. To do so, mortgage financing applicants are required to establish that they can manage that mortgage debt not just at current interest rates, but at higher rates that might be imposed over the life of the mortgage – the so-called “mortgage stress test”.
The process used by a mortgage lender in assessing a mortgage financing application has, essentially, three steps, as follows.
- Does the applicant have a sufficient down payment?
In order to purchase any home in Canada, it’s necessary to make a down payment, and the amount of required down payment depends on the purchase price of the home, as shown in the following table.
|
Purchase price of the home |
Minimum amount of down payment |
|
$500,000 or less |
5% of the purchase price |
|
$500,000 to $1.5 million |
5% of the first $500,000 of the purchase price; and 10% for the portion of the purchase price above $500,000 |
|
$1.5 million or more |
20% of the purchase price |
- What are the applicant’s GDS and TDS ratios?
Once the mortgage lender establishes that the prospective homeowner is able to make at least the minimum down payment, the next step is to determine whether they have sufficient income to manage ongoing mortgage payments.
That ability to manage such payments on an ongoing basis is determined by measuring the applicant’s income relative to their mortgage and non-mortgage debt obligations – in other words, by calculating what percentage of the applicant’s income must be allocated to debt repayment.
The first formula used to determine that percentage is what’s called the Gross Debt Service (GDS) ratio. For any mortgage financing applicant, the GDS is arrived at by adding together mortgage payments, property taxes, heating costs, and (where applicable) 50% of any condominium fees. The total of those costs should be no more than 39% of the applicant’s total income (or total family income for a couple).
Of course, most Canadians don’t have only mortgage debt – often, there are car loans, lines of credit, credit card balances, spousal or child support obligations, and, for younger Canadians, student loan debt. Consequently, the second formula used by the lender determines what percentage of the applicant’s total income is required to meet all of those debt obligations on an ongoing basis – known as the Total Debt Service (TDS) ratio. For TDS, what the lender wants to see is that the total cost of servicing all debts (including the housing costs listed above) is no more than 44% of the applicant’s total income.
- Can the applicant pass the mortgage stress test?
Most would-be homeowners who have saved to put together a sufficient down payment and whose income amount and debt obligations enable them to satisfy both the GDS and TDS debt servicing ratios would conclude that they should have no trouble in being approved for mortgage financing. However, there is one further hurdle to overcome, and it is that hurdle that can derail a mortgage financing application, particularly for first time homebuyers.
That hurdle is the mortgage stress test, which was first introduced by the federal government in 2018, and is intended to ensure that prospective homeowners will be able to continue to meet their mortgage payment obligations even when the interest rate levied on those obligations increases.
Interest rates are, of course, not static, and the range of interest rates which might be imposed over the typical 25-year life of a mortgage can be significant. For example, a homeowner who took out a mortgage in 2005 could, in the years between 2005 and 2025, been subject to interest rates on a five-year fixed rate mortgage ranging from 3.20% to 6.81%.
While no-one knows where interest rates are headed at any given time, what the mortgage stress test attempts to do is measure a borrower’s ability to absorb an increase in their mortgage interest rate and, consequently, their required mortgage payments. In order to do so, lenders must measure the applicant’s ability to meet the required GDS and TDS ratios, not just at the interest rate which will actually be levied on the mortgage, but (as part of the mortgage stress test) at the higher of the following rates: 5.25%, or the interest rate the applicant negotiated with their lender plus 2%.
As of the end of October 2025, the interest rate on an average five-year fixed rate mortgage is around 4.5%, meaning that a mortgage financing applicant will be required to meet the GDS and TDS ratios using a notional mortgage lending rate of 6.5% (being the higher of 5.25% and the actual mortgage lending rate plus 2%).
The impact that the mortgage stress test can have is illustrated in the following example.
A couple wants to purchase a home for $750,000, and have saved the required minimum down payment of $50,000. They have a car loan of $400 per month, but no other debts, and their combined total income is $150,000 per year. Property taxes on the home to be purchased are $4,800 per year, and the estimated heating costs are $1,500 per year. They have applied for a five-year closed mortgage, for which the current interest rate is 4.5%.
The GDS ratio for the couple is calculated (in rounded figures) as follows:
Annual mortgage payments at $3,900 per month = $46,800
Annual property taxes = $4,800
Annual heating costs = $1,500
Total housing costs are $53,100, which is 35.4% of their total income, under the GDS required percentage of 39%.
When the couple’s required car payment is added, their total debt repayment obligation increases to $57,900 for the year, making their TDS ratio 38.6%, again well below the mandated 44%.
In order to determine whether the couple can meet the mortgage stress test, their prospective lender is now required to determine those GDS and TDS ratios at a notional mortgage interest rate of 6.5%. The change in interest rate increases their annual mortgage payment obligation to $56,400, making their total housing cost $62,700. When the GDS ratio is calculated based on the higher notional housing cost, it increases to 41.8% – higher than the allowed 39%. When their car loan payments of $4,800 per year are added in, their total debt repayment costs become $67,500 and their TDS ratio increases to 45.0%, also higher than the allowed 44%, meaning that they cannot satisfy the required mortgage stress test.
Would-be buyers who find out that they cannot qualify for a mortgage because they are unable to pass the mortgage stress test face some tough choices. The courses of action open to them to change that result depend, in part, on why they were unable to meet that stress test.
Mortgage applicants whose GDS ratio is acceptable, but who cannot meet the required 44% TDS ratio can change that result by reducing their cost of servicing non-housing debts. Generally that means paying off, or at least paying down, such debt as credit card balances, car loans, or student loans.
Mortgage applicants who cannot meet the required 39% GDS ratio face a tougher choice. There are, practically speaking, only three ways to improve that score: earn more income, increase the amount of down payment, or purchase a property which has a lower cost. The first of those alternatives isn’t really within the control of applicants, certainly not in the short term, and most first-time home buyers have scraped together every possible source of funds to put together the down payment they already have. Increasing the amount of that down payment by additional saving can be done over the long term, but not likely the short term.
It is, of course, possible to borrow to increase, or even create, a down payment, but there are significant risks to doing so. Unless those funds come from a source (usually meaning family) which will provide them interest-free and not require repayment on a regular schedule – or will simply provide such funds as a gift – taking on interest-bearing debt which must be repaid on a set schedule for both a down payment and a mortgage often puts first time homeowners at risk of overextending themselves and ultimately struggling, or even being unable, to meet their mortgage and non-mortgage debt obligations.
The practical and far less risky course of action where the application of the mortgage stress test means that would-be homebuyers can’t get approved for a mortgage is to reduce expectations somewhat and purchase a less expensive property – a smaller house, or a townhouse instead of a detached home, or even, where practical, a house in a less expensive location. Especially where first-time buyers are seeking to take advantage of the current drop in house prices as well as lower interest rates, it can be worth reducing expectations in order to accomplish that important and difficult first step on to the property ladder, and begin the process of building the equity which will enable the purchase of their “dream home” in the future.
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.
