When applying for a mortgage, it’s crucial to consider your effort rate. However, it’s equally important to know that banks also use a stress test, commonly referred to as the stress rate, to determine whether they will approve your loan request.
Effort Rate and Stress Test: Different Concepts
Yes, they are different. Financial institutions use both to assess whether or not to approve your loan application. This is because both measures relate to your ability to meet financial commitments.
Effort Rate: What Is It and Why Do Banks Use It?
The effort rate represents the portion of your net income allocated to your financial obligations, expressed as a percentage. In other words, it is the ratio between your total monthly financial commitments and your net salary.
To calculate yours, sum up your monthly payments for existing loans (including credit card payments), add the expected monthly mortgage payment (if you don’t know it yet, you can simulate it here), and divide by your monthly net income. The ideal maximum effort rate is 35%, but some financial institutions may set different limits.
Banks use the effort rate to determine whether you have the financial capacity to repay the loan you applied for. This is because they assume that, in case of financial difficulties, you may stop paying your loans to cover other essential monthly expenses, such as food.
Stress Test: What Is It and Why Do Banks Use It?
The stress test consists of applying a percentage increase to the interest rate in effect at the time of the loan application and recalculating your effort rate. The purpose is to ensure that, even if interest rates rise, you will still be able to afford your loan payments.
For example, if your effort rate at the time of the mortgage application is 35%, but after applying the stress test, it rises to 50%, your loan request is likely to be declined.
What Data Do Banks Use for These Calculations?
Banks calculate your effort rate based on your declared monthly income and existing financial obligations. To obtain this information, they consult the Central Credit Register of the Bank of Portugal, specifically your Credit Responsibility Map, which you must authorize them to access when applying for a loan. You may refuse this authorization, but in that case, the bank will not proceed with your credit application.
Additionally, as required by the Bank of Portugal, banks must apply the stress test before making a final decision on whether to approve or deny your loan.
The Stress Test Rate Is Set by the Bank of Portugal
With the introduction of Instruction No. 23/2023 by the Bank of Portugal, the stress test rate for variable or mixed-rate loans has been adjusted as follows:
- 0.5% for loan terms of 5 years or less (previously 1%)
- 1% for loan terms of more than 5 years and up to 10 years (previously 2%)
- 1.5% for loan terms exceeding 10 years (previously 3%)
This reduction in the stress test rate makes loan approval easier, as it lowers your adjusted effort rate. However, it also means that you must exercise greater control over your finances.
Get in touch with Lead Kash
Now that you understand the differences between the effort rate and the stress test, it’s essential to evaluate how they apply to your financial situation. If you need guidance on the best way to manage this, Lead Kash is here to help.
Contact us, and we will assist you in finding the most suitable financial solution for your needs—with total transparency and no additional costs. Let us simplify your financial life so you can achieve your goals with confidence.
