Anatomy of mortgage changes

There is little doubt that housing sales have slowed down in the past year, due in large part to stricter mortgage regulations. Part of those regulations is a mortgage stress test that requires borrowers to qualify for an interest rate that’s at least 200 basis points higher than the contracted rate. 

 Those in favour of the stress test saw it as a way to improve housing affordability by thinking it would result in falling home prices, as well as protecting homeowners from potentially higher interest rates at renewal.

While there were some house price reductions, there was also a major slowdown in house sales, which, one could argue, has helped fuel a slowing economy. 

History

The most recent round of mortgage rule changes came into effect in 2016, then in January 2018, more changes were introduced, including using the stress test to qualify for uninsured loans.  This had the greatest impact.   The next month, in February, sales declined in greater Toronto by 35% from those recorded in February 2017.  This past month (February, 2019) housing sales in greater Toronto were even 2.4% lower than a year ago. 

Housing sales in greater Vancouver were even weaker, with February 2019 sales 33% lower than the same month in 2018. In fact, February 2019 sales are 43% lower than the 10-year average for sales in February.

Evan Siddall, who heads Canada Mortgage and Housing Corporation (CMHC), believes the stress test is bitter medicine that is working fine. Siddall credits the stress test for lowering housing prices. His comments were based on the stress test being introduced to lower housing prices; however, Carolyn Rogers, the Assistant Superintendent at OSFI, said something different in her speech to the Economic Club of Canada.

She explained, the stress test “was designed to target mortgage underwriting standards.” In her words, the test was intended to provide a safety buffer so that borrowers do not “stretch their borrowing capacity to its maximum.”

Is it plausible that OSFI and the CMHC had two different goals? Maybe.  OSFI’s goal did indeed lower high-risk lending somewhat as reported by the Bank of Canada. House prices did drop slightly.

It appears the government may have overshot its mark with the stress test, and the slowdown in the housing sales may have been an unintended consequence. 

Pushback

Many housing and mortgage industry voices started to lobby the government -- some believed the stress test was working fine, other’s say the impact has been devastating to home buyers, especially first-time homebuyers.

CIBC economists, Bejamin Tal and Royce Mendes predicted in November, 2018 that the housing market would be a drag on Canada's economic growth in the coming year. Residential investment accounts for 7.5% of Canada's economy.

"It was a good run while it lasted, but the sun has officially set on the days of heady housing market growth fuelling Canada's national economy," Tal and Mendes wrote. “And that could be bad news because housing investment is more important to Canada's economy "than at any other time on record," they added.

Proposed solutions

Two ideas emerged from various stakeholders and associations -- lower the stress test threshold that requires borrowers to qualify at least 200 basis points above the contracted rate; and/or reintroduce the 30-year amortization for CMHC insured mortgages.

Government response

The Liberal government introduced the following two measures in their recent budget announcement to address the issue of housing affordability and first-time home buyers.

Home Buyer’s Plan Withdrawal Increase. Effective immediately, first time home buyers can now withdraw up to $35,000 from their RRSP, tax free, up from $25,000, for a down payment. If you have a co-borrower, that total could be up to $70,000. 

A first-time homebuyer, as defined by the Canada Revenue Agency, allows repeat homebuyers to also be classified as “first-time” if they or their spouse haven’t occupied a home, they owned in the prior four years. 

Funds must be repaid over a 15-year period or the money gets added to your income for tax purposes. Starting in 2020, those who separate from a spouse or common-law partner will get to use the Plan, even if they’re not a first-time buyer.

First Time Home Buyer Incentive

Billed as a “shared equity mortgage”, the government will lend first-time home buyers’ money to buy a home. According to the budget document, this new incentive “enables homebuyers to reduce the amount of money required from an insured mortgage without increasing the amount they must save for a down payment.”

The government has earmarked $1.25 billion over three years, administered by Canada Mortgage and Housing Corp. (CMHC), to provide up to  5 % of the cost of an existing home and 10% of a new home through what amounts to an interest-free loan to be repaid when the property is sold. 

Key points: 

•  Borrowers must have a down payment of at least 5% -- but less than 20% -- and a household income under $120,000.
•  The insured mortgage plus incentive, combined, cannot be greater than four times the participants’ combined annual household incomes.
• Condo purchases are allowed.
• The program is expected to start in September 2019 with further details to come this year. 
•  If you use it, the government will share in price gains or losses when you sell. (The government hasn’t released many details on this yet) 
• While the Department of Finance has not commented on this, the program is called a “shared equity mortgage”, so it may be safe to assume it will be a registered second.
•  You must be a first-time homebuyer. (We don’t know whether the government’s definition of “first-time buyer” will be the same as with its RRSP Home Buyers’ Plan (see definition above)
• Your mortgage must be default insured. Buyers may use any of the three insurers.
• There are no monthly payments required on this incentive money
• You have to pay the money back when you sell your home. There was no mention of what happens during a refinance but if similar programs abroad are any guide, a cash-out refi would trigger the repayment provision. 

Aftermath

Paul Taylor, CEO of Mortgage Professionals Canada, which represents the mortgage-brokerage channel, said in an interview with the Globe and Mail, he is disappointed that the government did not heed his organization’s calls to reduce the stress-test burden, which is keeping many home buyers from qualifying for mortgages.

But he said the new interest-free loan program will help the earners most affected by the stress test, so it may be a good alternative. The program requires more analysis to assess how successful it will be, he said.

His organization estimated that the stress test would compel about 200,000 potential home buyers to change their plans in the first two years of operation. If 100,000 are helped by the loan program over three years, “a good chunk” of people most impacted may be getting help, he said.

Many other key details, including precise repayment terms and maximum available loans, have yet to be addressed.  The government says CMHC will release full details later this year. That’s a long time, politically speaking and things could change again, given it’s an election year.

We will continue to monitor these announcements and update our readers as new information comes top light.

Housing affordability continues to erode

New mortgage rules, rising interest rates, and stress tests have definitely cooled housing market activity by making it more challenging for some to qualify for mortgage. An unwelcome consequence continues to be eroding affordability -- as sales activity slows down, house prices have continued to go up, and not only in major urban centres. 

In the first quarter of 2018, home affordability eroded further at the national level – the 11th straight quarter of declines, according to a report by the National Bank. The bank measures affordability as the mortgage payment on a median-priced home as a percentage of median income. Last quarter, the metric rose by 1.2 points in Canada. The higher the metric, the worse the housing affordability.

The bank also suggests that as interest rates rise, affordability will continue to decline, setting the stage where prices have nowhere to go but down. But when? And will it be too late?

The National Bank report also says that by the end of 2019, prices would need to fall 2% in Toronto and Vancouver to keep home affordability from eroding further.

Economists have been predicting a more stable, balanced economy where people are happily working and are able to pay their debts; where interest rates are “low normal” and where house prices are affordable.  Well, that was a few years ago. The once booming real estate sector is in a bit of a slump. 

The Canadian Real Estate Association (CREA) reported that national home sales on the MLS were down 2.9% in April 2018, to the lowest level in more than five years. About 60% of all local housing markets reported fewer sales.

According to Will Dunning, Chief Economist, Mortgage Professionals Canada, data for the first quarter of 2018 points to a sharp slowdown. For the first quarter, the sales rate was 10.3% slower than in 2017. The average price in Canada was $482,782– a 4.8% drop compared to a year ago. However, when we look at the price index as opposed to averages, which can be easily skewed, Dunning reports a different picture.

The index from CREA shows that in the first quarter of 2018 prices were 6.4% higher compared to a year ago. The index from Teranet/National Bank shows a rise of 7.6%. Price growth is strongly influenced by the balance between supply and demand, which can be measured using the sales-to-new-listings ratio. The data from CREA indicates that the ratio was 56.6% in the first quarter. Based on that ratio, Dunning expects house price growth in many areas of Canada, which is what is indeed happening.

We are living in strange times. World economies have changed; NAFTA is at risk and our economy might start to feel the effects of a trade war with the US. The new mortgage-insurance rules and stress test have indeed impacted the market, especially for the first-time homebuyers.

In an April 2018 survey by West Coast Capital Savings, 60% of young British Columbians (18 to 29 years old) believe it’s impossible to buy a house in the province’s pricey real estate market and are “seriously considering” moving to areas where home ownership is less costly.

While some homebuyers can adjust their housing expectations and move to buy something less expensive, some potential buyers will be knocked out of the market. And will there be enough, good inventory available for purchase?

There is no arguing that the market has cooled, but it has not stopped. We have not yet heard of massive foreclosures, which mean that households continue to pay their mortgages and their debts. 

So, the big question is when will prices really start coming down in a way that will make housing affordable again. 

We need to continue to closely watch the market to determine if rising rates and lower home values are a blip or a trend which will ultimately impact long term affordability for Canadians.

Is real estate a good investment? The long answer is yes

It seems it’s a tough world for Gen Y’ers – high student debt, shortage of jobs, living with parents longer, and now the dream of home ownership might have to wait. Yet, an RBC poll released early in April found that young Canadians see home ownership as a good investment and 41% of the respondents plan to buy. The poll also found that 86% of those aged 25-34 believe owning a house or condo is a solid investment, up from 78 % last year.

So is real estate still a good investment?  The RBC poll confirms that it might be, at least as far a millennials go.  “The increase in the number of those who feel the housing market is a good investment, as well as the number of those who intend to buy, really highlights that Canadians have no doubt in the strength of the housing market”  said Erica Nielson, RBC’s vice president of home equity finance, about the poll results.

Here’s how the results breaks down per province:

• Ontario, Quebec and the Prairies saw the biggest surge in home-buying interest over last year
• Ontario, 24% said they have intentions to buy this year, up from just 14% in 2013.
• In Alberta, 28 % said they hope to buy this year, up from 22 % in 2013.
• Atlantic Canada also saw some increase in buyer intentions.
• In B.C. the percentage of those who are likely to buy a home has increased slightly, from one-in-five (20%) in 2013 to more than one-in-five (22 %) in 2014.

Interestingly, a discussion initiated by the Globe and Mail asking the question about real estate as an investment received a lot of attention. Those who answered do believe that a home is an investment that builds wealth in addition to it being a place to live.

Let’s take a closer look at that. Those who are pro a home as a good investment will point to the increase in resale prices over the past 10 years, which have increased more than 6% annually since 2000, according to the Canadian Real Estate Association (CREA), which is triple the inflation rate. This increase helped improve a household’s net worth, unless you were under the age of 35.

In February, Statistics Canada reported that the median net worth for families increased 78% from 1999 to 2012 on an inflation-adjusted basis, or about 4.5% a year. However, in households where the age of the highest earner was under 35, net worth grew just 8.6% in total, or about 0.6 per cent a year. Since inflation averaged 2.2 % over that period, as reported by Rob Carrick in the Globe and Mail, “those young-adult households actually lost net worth on what economists call a real basis.”

That’s not really a surprise since gains in net worth have been driven by real estate appreciation and those under 35 years of age have less equity in their homes. Can they catch up? Well, prices can’t rise indefinitely – so say many economists – so that may not be helpful when trying to make a sound financial decision.  However, there are a few hot markets in the country that might buck the trend.

For example, in Alberta, and especially in Calgary, real estate is a growth industry. Heather Manna, Managing Partner and Mortgage Broker at TMG Millennium Mortgage Group in Calgary says that real estate definitely is a good investment. “Over the last few months we have seen lenders loosen the reins on financing restrictions, which is making it easier to qualify a consumer who is in the market to purchase a new home,” she said. “This, combined with the low mortgage rates, continues to make real estate a great investment, whether you are buying to occupy the home, or purchasing for an investment.”

And why not invest in real estate, Manna asks? “Just like the stock market there will always be lows and there is always a correction. It’s about keeping well diversified and that includes having your home in your portfolio,” she said. “If you need a roof over your head, you might as well be paying your own mortgage down instead of someone else’s.”

There is also a shortage of listings in the Calgary market, which is upping the prices there. The rental market is also very tight with a 1% vacancy rate. “If not purchasing a property long term for your family, the rental market proves to be aggressive year-after-year for income earning potential or a retirement plan,” Manna added.

Granted, Calgary may be an exception, however there are similar hot markets in both B.C. and on the Prairies. Ontario and the Atlantic provinces have hot areas. Some economists say that prices will struggle to show any real gains in the next five to 10 years unless you happen to be in a hot market. But in some of those markets affordability is the real issue and young people are looking for help with larger down payments from their parents.

The hidden story for Gen-Y’ers is debt load. Statistics Canada says under-35 households owed $36.44 per $100 in assets in 2012, by far the highest of any age group. Purchasing a home adds to that debt load, not only with mortgage payments, but interest, property taxes, insurance and maintenance costs. If there is a modest 5% drop in house prices, then a 5% down payment equity position is wiped out.

However, in a Globe and Mail article published on Wednesday, April 23, Will Dunning, chief economist of the Canadian Association of Accredited Mortgage Professionals (CAAMP) says he thinks that home prices have turned.

Using data from the CREA, he said that sales of existing homes rose last summer and peaked in the August-September period. Although here has been a slight rise during the past two months, he doesn’t see this as meaningful.

Dunning referred to the Teranet-National Bank home price index, which shows a very gradual increase in prices over the last while. “If you take the price index and seasonally adjust it, it shows a sharp pick-up in price growth around the time I would have expected it to have occurred, and “the last data point hints that on a seasonally-adjusted basis, the period of rapid growth has ended – when it should have.”

With prices stabilizing, low rates, larger down payments, real estate starts to look better, especially as a long-term investment, which it actually should be. There was a time when a couple would buy a house, live there, raise their family there, and then retire there, mortgage free. We may be coming into those times once again.

 The most important question to ask is, “am I ready?” Consider a home a long term investment -- its value will fluctuate up and down over time, but eventually you’ll be mortgage-free. It’s a big commitment, but it’s also a great achievement. Home ownership offers a great deal of personal satisfaction, as well as financial stability.

There is no right or wrong time to buy a house. Mortgage rates and house prices will fluctuate but over the long term, home ownership is still a sound investment. 

Ask yourself:

•  Are you at the point in your life where the idea of home ownership is attractive and makes sense, both now and for the long term? 
• Do you qualify for a mortgage, and how much? If you don’t know, talk to a mortgage professional.
• Can you manage the mortgage payments as well as other expenses that may come along with home ownership, such as maintenance costs and higher insurance fees? 
• Do you have a down payment?
• Do you have a strategy to take advantage of this low interest rate environment to more aggressively pay down your mortgage and accumulate equity?

If you answered yes, then it’s the right time to invest in real estate.

Housing collapse? What housing collapse?

Bad news trumps good nearly every time in the media, especially in the financial media. Interest rates are going up, interest rates are getting cut. Consumers are in trouble with too much debt, consumers can handle their debts. We’re in a recession, were in a depression, we’re fine. There’s the housing bubble that never happened, but some are still waiting for it, and the latest -- escalating house prices and lack of affordability.

For the most part, the constant worry reporting by the media and the economists and pollsters who feed those headlines is overblown.

We have low interest rates, which will likely be here for awhile. We’ve heard how rates are on the uptick, but we’ve been hearing that since 2010 – it’s like the boy who cried wolf.  While it’s true that fixed rates did go up slightly, we’re back to discounted variable rates at 2.6%. And those 5-year fixed rates are sitting at 3.39% or less. We’re back to the future!

A look at housing prices across Canada and we see a picture that’s not so bad. Sure, the two inflated markets—Toronto and Vancouver – have crazy pricing, but in the rest of Canada, house prices seem to be rising at modest levels, unless, of course, you’re buying in a hot market – these markets come and go. 

StatsCan’s latest survey of financial security, released on February 24, shows that the median net worth of Canadian households reached nearly $244,000 in 2010. That’s up 44.5 per cent since 2005. While debt still remains historically high -- $27,368 (less mortgage debt) in the fourth quarter of 2013 according to Trans Union, most Canadians are wealthier than they’ve ever been.  

Overall, total family assets in Canada rose to $9.4 trillion in 2012, with the value of families' principle home representing one third of the total assets. Pension assets, including employer plans and private pension plans, made up 30% of the total, while other real estate holdings — rental properties, cottages, timeshares and commercial properties — represent almost 10%.

Will there be a rebalancing or a correction? It’s true that, after a long period of spending, consumers will cut spending to pay debt; however, Benjamin Tal’s (Deputy Chief Economist for CIBC), Weekly Market Insight Report, found that consumer spending rose 3.1% in the fourth quarter of 2013 and the savings rate remained stable at 5%.  Household debt is still a concern because it is still rising, albeit it more slowly than in previous years. 

Low interest rates, coupled with steady job creation, and a slight increase in wages, bodes well for the future of housing.