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.