Where’s the tipping point?

Guest Blog by Mark Kerzner, President, TMG The Mortgage Group
 

We have a new development in the mortgage industry. We have The Office of Financial Institutions (OFSI) looking at exerting their newly-given influence on the mortgage guidelines in Canada.  The fact that OFSI has been granted additional responsibilities that include oversight of key lending guidelines -- vis-a-vis what CMHC will insure and therefore what the banks will lend on -- seems to simply be a catalyst to accelerate additional guideline policy changes. Make no mistake about it; these were discussed long before OFSI came onto the scene.

The Government made a number of credit changes following the Global Economic Crisis to instill more responsible lending practices and reduce the risk of a similar housing meltdown that was experienced in other countries, including the US. In retrospect, those changes -- reducing maximum amortizations, increasing down payment requirements on rentals, reducing the amount you could refinance, etc., were prudent. After all, house prices continued to appreciate, real estate activity remained strong and arrears levels remained muted.

And even more recently (since January 2012) we have seen the banks further tighten their own lending guidelines in the absence of formal required changes as set out by the Minister of Finance. An example would be the additional tightening of the Business-for-Self and Equity programs.

The Canadian economic recession was relatively short lived following the global economic meltdown. In fact, Canada was the first significant country to increase its overnight rate in June 2010. The Bank of Canada continued to increase it three more times in the summer of 2010 to 1%. So, given we have already survived the various credit and qualification changes and our market has remained strong, why am I concerned at the prospect of further tightening?

For me, it starts with this question: Where is the tipping point? What change will cause our market to slow down, which is the obvious goal, and what change could cause our market to head into a tail-spin? Or will the market remain the same whether changes are made or not? I don't have the answer for this but the last time I felt this way I was playing PLINKO with my kids not knowing which straw would cause the remaining balls to fall.

My sense is that if there are additional changes focussed on ensuring affordability and suitability -- that would make sense. Those are responsible changes. However, if as an industry, we have to re-evaluate how a renewing customer who has a perfect repayment history has to requalify for a mortgage - that is worrisome. That is the type of change that, in its worst case scenario, could force an increase of supply of homes in the market from people forced to sell because they can no longer qualify BUT who had no intention of defaulting on their mortgages.

Changes focussed on refinances and renewals may impact those with a proven ability to make their payments.  It is not impacting potential supply (ie. new construction) but existing supply.  On top of that, a large percentage of additional funds taken out in refinances are used in home improvements, which increases the value of the property, and for consumer spending. A slowdown of either of these two components could prove problematic. And let us not forget that guidelines now require a minimum of 15% equity for a refinance – up from 5% just a few short years ago.

I understand why a slowdown is desirable. I have heard some experts say, "If there isn't a slowdown it makes a crash more likely.”  I get that, and I support that position. I just want to ensure that a manufactured slowdown targets habitual borrowers and not the demonstrated responsible ones.
 
There are more guideline changes and restrictions coming. The Bank of Canada, the Minister of Finance and many regulators would like to see the Canadian housing market cool off. However, changes must be stress tested against the worst case scenario, which would be triggering a market collapse.

What we know about you – mortgage consumers

The 2012 Mortgage Consumer Survey prepared by Canada Mortgage and Housing Corporation (CMHC) tells those in the mortgage industry a lot about you, the consumer – your buying habits, where you go to look for information, the kind of information you look for, etc.

The online survey was completed over February and March of 2012 by more than 3500 mortgage consumers who had completed a mortgage transaction in the previous 12 months. Here are few highlights of that survey:

Online Activity 

•  When researching mortgage information, 71% of consumers went online; this is up from 65% in 2011.
• Facebook was the most popular social media network used to gather information, especially among first time home buyers.
• The two most actively searched items were interest rates at 86% and mortgage options at 73%.
• And not surprisingly, 38% of 18 to 24-year-olds used mobile mortgage apps.

Using Professionals

•  Consumers are turning more to mortgage professionals to help them with their mortgage decisions.
• Consumers are asking a lot more questions about mortgages – 71% asked about differences between mortgage products; 67% wanted information about mortgage loan insurance; and 67% asked about penalty clauses.
• Consumers like referrals and most referrals come from a family member or a financial planner.

The Mortgage Process

• Before making a decision about a mortgage, consumers spend about five weeks doing research; first time home buyers spend  about eight weeks.
• Consumers are now more prepared when meeting with their mortgage professional and come armed with a list of questions and the necessary documentation.
• Eighty per cent of consumers felt confident they made the best decision with their mortgage product.

Mortgage Free

• Thirty-one per cent of mortgage holders made lump-sum payments or increased their regular payments to pay off their mortgage sooner.
• Nearly half of all buyers set their monthly payment higher than the minimum to pay off their mortgage sooner.

The survey findings are positive indicators that consumers are increasing their knowledge about financial matters. Four in ten home buyers went online and did a financial self-assessment. And a whopping 80% felt they had a good understanding about how much they could afford and what options were available to them.

Consumers who educate themselves about the financial options available will learn how to make consistent, informed financial decisions and that will help them to achieve their goals. This survey shows that Canadian consumers are on the right track.

The survey also makes clear that mortgage professionals are in a unique position to help educate consumers about their mortgage options and ways to pay off that mortgage sooner. 

Where can the economy go to grow?

Two recent reports from Stats Can offer good news for the economy. In April, 58,200 more people found full-time work -- this is the second month in a row there has been an increase in jobs.

Further, the pace of household debt has slowed to levels seen prior to 2002. Delinquencies are down on lines of credit; there is healthy demand for auto loans and outstanding mortgage loans are below the rate of growth seen in the past two years.

What we have right now is a stabilizing economy. We also have an economy getting ready to grow.  And with that, there are new questions surrounding when and if the Bank of Canada (BOC) will raise interest rates this year and even questions about where will growth come from and how will we grow.

The slower pace in consumer credit markets, the federal government warnings of mounting debt loads and recent changes to mortgage rules have kept home prices in check.

Increasing construction starts are also a sign that the housing industry foresees good days ahead. And low interest rates are keeping buyers buying.

The challenge for the government and the BOC is how to keep the economy growing healthier and stronger in a world where global economies are weak. The US economy sputters along not knowing where to go, or if it should go at all. European countries can’t seem to reach financial consensus and emerging market economies like China have turned out to be weaker than expected.  No country is an island and Canada must be realistic about its current growth potential. We are in an enviable position but we have to wait for everyone else to catch up.

Should the BOC raise its overnight rate? In a recent CIBC report, economist Avery Shenfield wrote, “It’s not about whether Carney will look at June, July or September to strike, but whether the economic news this year will be sufficiently buoyant to raise rates at all.”

A rate hike at this time will directly impact consumers and may slow consumer credit markets even more, which would adversely affect our manufacturing sector and retail sales. With our largest trading partner not planning any rate hikes until 2014, it might be prudent for Canada to wait it out.