【Mortgage tips 2023】What factors affect the mortgage stress test?
A mortgage stress test is a financial evaluation used by lenders to determine a borrower's ability to repay a loan under challenging economic conditions, such as a rise in interest rates. In Hong Kong, stress tests are used to assess the borrower's ability to repay the mortgage based on the borrower's income, expenses, and credit history. The results of a stress test can impact the amount a borrower is able to borrow for a mortgage and the interest rate they receive.
Debt Servicing Ratio is a measure used by lenders to assess a borrower's ability to repay their debts. The DSR is calculated by dividing a borrower's monthly income by their monthly debt repayments, including mortgage payments, credit card payments, and other loans. In Hong Kong, the maximum DSR typically allowed by lenders is around 60%.
For those individuals with irregular income, it may be harder to pass the stress test as the lender will be assessing the borrower's ability to repay the loan based on a worst-case scenario interest rate. The calculation for individuals with irregular income may be different from those with regular income, as the lender may require additional documentation or information to assess the borrower's financial stability. In this case, the lender may use an average of the borrower's income over the past few years or take into account the borrower's other sources of income to determine their ability to repay the loan.
The borrower's current loan such as personal loan, tax loan, pay-in-installment, student loan can affect the result of the stress test as it will impact the borrower's debt-to-income ratio. To prevent it from affecting the stress test, the borrower can make efforts to pay off their existing loans or reduce their outstanding debt before applying for a mortgage loan.
If the borrower already holds property, the lender will take into account their existing property and mortgage when conducting the stress test for their second property. The lender will assess the borrower's ability to repay the new mortgage in addition to their existing monthly payments. This means that the minimum income requirement for the second property may be higher than if the borrower were applying for their first property. In some cases, the lender may also consider the borrower's financial position, including their credit score, debt-to-income ratio, and income stability when assessing their ability to repay the new mortgage.
|First Home||Second Home|
|Loan To Value Ratio||60%||50%|
|Debt Service Ratio||50%||40%|
If you are planning to purchase a home unit, especially a new one, you generally do not have to go through a stress test. Banks will accept your mortgage application as long as you meet the income-to-debt ratio. However, if the unit is part of the HOS, the income review will be stricter and the stress test will be conducted like a private house, meaning that after interest rates increase by 2%, the monthly payment cannot exceed 60% of the income.
There are online tools and calculators available, including on websites like mreferral, that can help you estimate the results of a stress test. These tools can provide a rough estimate of the amount you may be able to borrow for a mortgage and your monthly repayments under different interest rate scenarios. However, it's important to keep in mind that online calculators may not take into account all of the factors considered in a mortgage stress test and that the results may not be the same as what a lender would determine. For a more accurate assessment of your mortgage eligibility, it's best to consult with a financial advisor or a lender.
Here are examples of stress test calculations, assuming:
- Interest rate: 3.375%
- Repayment period: 30 years (360 months)
- Stress test interest rate: 3.375% + 2% = 5.375%
- Property value: $10,000,000
- Loan amount: $10,000,000 x 80% = $8,000,000
Base on a maximum debt-to-income ratio of 60%, the monthly payment amount would be approximately $35,368, and the stress test minimum monthly income requirement would be approximately $74,663.
- Property value: $6,000,000
- Loan amount: $6,000,000 x 90% = $5,400,000
Base on a maximum debt-to-income ratio of 60%, the monthly payment amount would be approximately $23,873, and the stress test minimum monthly income requirement would be approximately $50,397.
- Property value: $8,000,000
- Loan amount: $8,000,000 x 90% = $7,200,000
Base on a maximum debt-to-income ratio of 60%, the monthly payment amount would be approximately $31,831, and the stress test minimum monthly income requirement would be approximately $67,197.
A stress test considers several factors, including the borrower's income, expenses, credit history, and the proposed mortgage payment. The test also factors in changes in interest rates to determine the borrower's ability to make mortgage payments if rates were to increase. If a borrower fails the stress test, they may need to adjust their mortgage application, such as by increasing the down payment or choosing a shorter repayment period, to improve their chances of approval.
If the borrower cannot pass the stress test, they may not be approved for a mortgage loan. If this happens, the borrower can take steps to improve their financial situation, such as paying off existing debt, increasing their income, or adjusting their budget to reduce expenses. They can then re-apply for a mortgage loan once they have improved their financial situation. Alternatively, they can consider applying for a smaller loan amount or a loan with a longer repayment period, which may make it easier for them to pass the stress test. It is also recommended for the borrower to consult with a mortgage referral agent or lender for personalized advice and guidance.
Increase rental income
If you have a property that you rent out, you can include the monthly rental income in your monthly income. If the rental agreement is stamped, rental income can be calculated at 70%, but if it is not stamped, rental income can only be calculated at 60%. For example, if the monthly rent is 20,000, with a stamped agreement, 14,000 can be included in the income, but without a stamped agreement, only 12,000 can be included in the income. If the property is going to be rented out, it will be considered as potential rental income, and the bank will evaluate the rent, which will then be calculated at 60% (but keep in mind that if the monthly rental income is included, the ratio of payment to income becomes a monthly payment of no more than 40% of monthly income in the stress test (assuming a 3% interest rate increase), and a monthly payment of no more than 50% of monthly income is calculated).
Add a co-signer
If you can add a co-signer, the mortgage application can take into account both incomes. For example, if the ratio of payment to income requires 60,000, and the mortgage applicant still owes 20,000, if the co-signer's monthly income is over 20,000, the difference can be filled in. The number of co-signers is basically unlimited, but if there are too many, the bank will consider overall repayment capacity, the reasonableness of the relationship, and other information. Also note that if mortgage insurance is used and the mortgage amount is increased to 80% or 90%, the co-signer must be a direct relative, i.e. parents, children, or spouse, and unmarried couples can also be accepted, and they must reside in the local area. If you are applying for a mortgage of 60% or less, the co-signer does not necessarily have to be a direct relative, and other relatives can also be co-signers.
Calculating Total Income Including Bonus, Commission, and Double Pay
The applicant should re-calculate their current income, ensuring they have included any bonus, annual bonus, commission, etc. Double pay can be divided into 12 months and included in the monthly salary. For example, if the monthly salary is HKD 24,000 and there is double pay, the actual monthly income is HKD 26,000. The bank will require the applicant to provide proof of the double pay months, such as pay stubs, employment contracts, and bank statement. Bonuses and commissions can also be included in the income calculation, but the past 6 months' average value is usually used. However, some banks currently apply a 20% discount. For example, even if the commission average is HKD 20,000, the bank will only calculate it as HKD 16,000. It's recommended to check with the mortgage specialist before applying for a mortgage loan on the latest calculation method.
Including Side Business Income
If the monthly payment ratio is still not feasible after considering the full-time income, it's recommended to check if there is any side business income that can be included. However, the applicant must provide income records such as bank statements and have a good accounting record, keeping all receipts and accurately reporting taxes.
mReferral Affordability Calculator:
The mReferral online affordability calculator is a tool that helps the public to assess their affordability for a mortgage loan. The calculator provides an estimate of the monthly mortgage payments, based on the loan amount, interest rate, and loan tenure. It also provides information on the minimum income required to qualify for the loan based on the debt-to-income ratio. By using the online calculator, borrowers can get an idea of their monthly repayments and whether they are likely to pass the stress test before they apply for a mortgage loan. This can help to prevent stress test failure and can save time and effort in the application process.
Please note that the actual monthly payments and minimum income requirements may vary depending on the lender's specific requirements and the borrower's financial circumstances. It's important to consult with a financial advisor or a lender for a more accurate assessment of your mortgage eligibility and monthly repayments.
The loan-to-income ratio is intended to ensure that the income can cover the mortgage expenses. Real estate investment is a long-term investment. Before investing, it's important to consider the above and also to calculate one's current financial stability. If necessary, it's advisable to buy a pre-owned property first, then switch to a new one when the income increases. If there are any questions about the mortgage application, please feel free to contact us.