Given recent comments by CMHC, the OECD, the Bank of Canada and several others that house prices in Canada are overvalued by 10% to 30%, plus the fact that the ratio of household-debt to income is near a record high,it is not surprising that recently appointed Minister of Finance Bill Morneau announced yet another tightening of mortgage finance regulations.
Under the new regulations, home purchasers of expensive properties wishing to qualify for government-backed mortgage insurance will,after February 15, 2016, be required to put down 5% of the value of the home on the first $500,000 plus 10% down on the amount over $500,000 up to $1 million. Homes over $1 million do not qualify for mortgage insurance.
To gauge the potential impact of this latest change in mortgage regulations, it is worth taking into account that this is the fifth time the government has attempted to “cool” the housing market by tightening the rules for insured mortgages.
First, in July 2008, the government raised the down payment requirement from 0% to 5% and cut the maximum amortization period from 40 years to 35. Next, in February of 2010, borrowers applying for fixed or variable rate mortgages with less than 5 year terms were required to qualify for a 5-year fixed rate mortgage.
In early 2011, the government reduced the maximum amortization length from 35 to 30 years, cut the maximum insured refinancing from 90% to 85% and eliminated insurance on home equity credit lines (Helocs).
Next, in mid-2012, the maximum amortization was cut from 30 to 25 years, mortgage insurance was eliminated on properties over $1 million and the insured refinancing maximum was reduced from 85% to 80%. Also in 2012,the minimum credit score (i.e., gross debt service as a per cent of disposable income) was fixed at 39% and the total debt service ratio at 44%.
Although not explicit in the Department of Finance’s announcement, it is quite clear that the government is attempting to cool sales in Vancouver and Toronto, the only two metro areas where (as the chart illustrates) average house prices exceed $500,000 and where, over the past year, prices have increased by 17.8% and 10.3% respectively. Excluding these two metro areas, house prices in Canada increased by 3.4% to an average of $345,900 in November.
From our perspective, the effect of this latest attempt by the federal government to cool overheated housing demand in the country’s two hottest markets will be limited by a number of factors.
First, according to data released by CHMC in September, only a relatively small percentage (appx 6% to 7%) of insured borrowers were issued loans of more than $600,000. This small percentage reinforces the view that the vast majority of home buyers in Toronto and Vancouver are second-time or foreign buyers who are able to qualify for a conventional uninsured mortgage by making a down payment of over 20%. Also, while higher prices are putting more domestic buyers on the sidelines, foreign buyers have been effectively insulated from the rapid rise in house prices by the 15% depreciation in the value of the Canadian dollar vs the US$ over the past 12 months.
Having said this, given that the rule change does not take effect until mid-February, we expect to see a significant uptick in January home sales driven by homebuyers who want to avoid putting down a larger down payment on homes valued between $500,000 and $1,000,000. However, the delayed impact of these new lending rules could cause housing demand to cool in the second half of the year, particularly in Vancouver and Toronto.