October 19, 2016

The mortgage rule change imposed by the Federal government is now in effect (Oct 17, 2016)

There are many opposing views on how the recently imposed rules will impact the Canadian Real Estate Market and related activities. Some believe that it would lead to a major price correction and others believe that could happen in smaller markets but not Toronto or Vancouver. The policy modification that has drummed up most conversations is the "mortgage stress-test". Benjamin Tal of CIBC believes that Feds meant "business" by introducing such policy and it would reduce the activities of those seeking CMHC insured mortgages (i.e. First time buyers, those with lower down payment...) by approximately up to 25%. CIBC's CEO Victor Dodig called imposed policies “prudent” and claimed that they will immune the country's Real Estate sector against various risks.

Cliff Iverson, The President of Canadian Real Estate Association (CREA) indicated that the Feds' recent changes to mortgage lending will inject uncertainty into the real estate market. He feels that the stress test will discourage purchasers from entering the market which simply means lower sales activities.

Another view claims that such a move will take pressure off Bank of Canada and that would help Poloz with keeping the overnight rate low and growing the economy with lower household debt. This also leaves some room for Bank of Canada to leash core inflation through monetary measures without imposing pressure on household debt.

Canadian Mortgage Broker Association has been in correspondence with the Finance Minister due to unsolicited imposed policies. CMBA has argued that new rules will not only impact the competition in the mortgage market and increase borrowing cost, it will also majorly impact millennial home buyers.

CMBA has recommended amendments and exceptions for the recent mortgage rule changes. The recommendations are as follow (quoted from Mortgage Broker News):

Recommendation 1 and Exemption Request:

Exempt all insured mortgages with terms greater than 7 years from the requirement from qualifying borrowers at the Bank of Canada's conventional five-year fixed posted rate, and permit qualification at the true contract rate associated with the term. Contract rates on a conventional 10-year term are already relatively close to the posted rate of 4.64, being approximately one per cent lower. There is also inherent stability in longer term mortgages, as borrowers do not experience fluctuations in mortgage payments as interest rates change. This means that stress testing borrowers of longer term mortgages are not necessary, and exempting them from the mortgage rules would help the government meet its mandates to make housing more affordable and strengthen the middle class. The CMBA notes that Canada is unusual in its lack of availability of longer term mortgages in the mortgage market. By contrast, the majority of mortgages in the United States (and numerous other countries) are for terms of 15 or 30 years Economic stability can be achieved by providing mortgage borrowers with a greater array of term options, including long-term mortgages.

Recommendation 2:

Permit first time home buyers to amortize insured mortgages over 30 years, instead of 25 years. A onetime exception to the 25-year amortization rule for first time home buyers would balance the need to make home ownership affordable with the need for Canada to have a stable economy. First time home buyers have the most significant challenge in affording housing and may be just starting out in employment with more limited income to both save for a down payment or make monthly mortgage payments.

Recommendation 3:

Modify the requirement of limiting amortizations on insured mortgages to 25 years, by enabling borrowers with a loan to value ratio of 70% or less to amortize up to 30 years. Borrowers with a loan to value ratios of 70% or less are low risk, and making them qualify with more stringent requirements serves a negligible benefit, and poses little risk to economic stability.

Recommendation 4:

Exempt all insured mortgages with principal amounts of $499,000 or less from the requirement to qualify borrowers at the Bank of Canada’s conventional five-year fixed posted rate, and permit qualification at the true contract rate associated with a 5 year fixed term. Many lenders will only lend in rural or smaller urban areas of Canada using portfolio insured mortgages and as a result, the new rules will disproportionately impact homeowners or potential borrowers hoping to acquire housing in smaller markets. This exemption would help ensure affordability in areas outside major city centers where escalating house prices are not an issue.

My personal views:

From a business standpoint, Mortgage stress-test actually works in favor of a company like GreenFlow Financial as most of our activities are concentrated in the Alternative mortgage lending arena. That being said, I would like to share my personal views on this matter with you.

Considering the activities from the ground level, the untenable price growth is showcased mainly in the lower density residential areas (Detached, semi-detach, towns...) and not as much in the higher density residential areas (low/high rise condos....). Excess supply or its lack of has had major effects on how the above-noted segments have performed till today.

By implementing the mortgage stress-test, in my view Federal government is aiming to use one of the demands controlling tools to address the shortage of supply mainly in lower density segment and as well to leash price growth; such a move, however, could cause excess supply (even higher than the current) in the higher density residential areas. On the other hand, this strategy will to some extent control the drummed up activities by local purchasers (specifically those with lower down-payments) but not other market participants.

In a scenario where execution of such policy has been most effective, even though the price equilibrium could be reached at some point in the lower density residential areas ( due to higher availability of supplies), the supply surplus could lead to sluggish price growth in the higher density residential areas.

In my view, this could be a most effective strategy when local buyers make up the majority of the market participants. In the current Canadian Real Estate Market where we are witnessing increased foreign investment due to weaker Canadian currency, the Federal government shall also consider implementing other measures that would prohibit foreign investors from contributing negatively (i.e. overbidding due to financial power) to the price growth and availability of supplies. Measures such as foreign tax and less lenient mortgage lending guidelines could be seen as balancing acts. Mortgage stress-test is only a good first step to controlling the activities domestically and mainly impact locals.

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