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Feds Nuke the Mortgage Market

bomb-154456_640The government dropped a bomb on the mortgage industry today, and disguised it as a firecracker.

Policy-makers imposed a range of new measures with the stated goal of improving housing “stability.” Here’s a summary from the Department of Finance –> DoF Press Release.

Preliminary official estimates are that 1 in 12 homebuyers could be affected. I don’t buy it. We’ve heard from numerous lenders and brokers today who estimate the actual number is twice that, maybe more. 

Here’s what all of this really means to you:

Mortgage Approval Just Got Tougher

  • If you get a variable or 1- to 4-year fixed mortgage, most lenders make you prove that you can afford payments at the Bank of Canada’s posted 5-year rate (currently 4.64%).
  • This rule currently does not apply to fixed terms of five or more years. But effective October 17, it will. From a mortgage qualification standpoint, that’s a ginormous change—equivalent to a 2.25-percentage-point rate hike.
  • Today, someone with 10% down who makes $50,000 a year can qualify for a $300,000 home purchase. That hypothetical maximum mortgage amount will plunge 18% to $246,000, once this rule takes effect in two weeks.
  • This one regulation alone could shut out more buyers from the market than possibly any of the prior rule changes, including the reduction in the maximum amortization from 30 to 25 years (announced in 2012).
    • Way back in 2012 when home prices were lower, Altus Group found that 20% of buyers could not qualify without an amortization over 25 years. So one might assume that at least 20% of homebuyers will have to reduce their purchase price, or find a bigger down payment or co-signor, because of today’s announcement.
  • Key points:
    • If you’re renewing with your current lender, you won’t have to requalify at these inflated rates. In fact, it’s routine that lenders don’t requalify you at all if you stay with them for another mortgage.
    • If you were planning to refinance to 80% loan-to-value (the legal maximum for a prime mortgage), try to get your application in by mid-next week. Borrowers will be sprinting to meet the deadline, so the sooner the better.
    • Is this new rule warranted? Perhaps if you put down less than 10% it is. But if you put down 10% or more, most people could refinance after five years into a 30-year amortization (if they really had to). Even at 4.64%, their refinanced payments would be lower than when their rate was 2.39%. So the government’s “reducing risk” argument is questionable if we’re talking about payment risk.

Rising fixed ratesMortgage Rates are Headed Up

  • Countless lenders rely on default insurance in order to resell mortgages, mainly because investors demand it.
  • Effective November 30, the government will no longer allow lenders to insure:
    • Refinances
    • Amortizations over 25 years (today you can get up to a 35-year amortization if you have 20%+ equity)
    • Purchase prices of $1 million+
    • Non-owner-occupied rental properties.
  • You may wonder, “OK, so what?” Well, here’s what: It means that all of these mortgage types above will have to be sold to, or originated by, lenders who hold them on their balance sheet. That will meaningfully limit your choice of lenders, and seriously dent rate competition.

Mortgage Rates are Headed Up – Part II

  • Another rule taking effect soon is the new higher capital requirements for insurers. This rule, announced well before today, will lead insurers to double insurance premiums on some mortgages, particularly those at 80% loan-to-value or less.
  • Again, many non-bank lenders rely on this insurance. It could force them to jack up rates by 10-20 basis points, depending on the lender, borrower qualifications and down payment.
  • Big banks don’t need to insure and sell their mortgages, so they should be less impacted than most lenders. The net effect is further deterioration of competition.

Mortgage Rates are Headed Up – Part III

  • The Feds reaffirmed their intention to evaluate “risk sharing,” whereby lenders must pay a deductible if an insured borrower defaults.
  • Depending on how it’s implemented, this rule could turn the lending industry on its head. It would force prudent lenders with less capital out of the market (or make them pay banks to cover the deductible for them). Either way, the costs will be borne by Canadian borrowers.

Fewer Cost-Effective Refinance Options

  • Fewer lenders will be able to offer competitively priced refinances, due to the new prohibition on insuring them.
  • Borrowers who can no longer roll their debt into a prime mortgage may have to resort to higher-cost non-prime lenders or unsecured debt. (Does increasing borrowers’ interest costs make for a more stable housing market? Not on this planet.)

Stealth Rate Hike

b2-spirit-taking-off-1070557_640Regulators have taken a systematic approach to raising lenders’ costs, and that’s not by accident.

This past summer there was reportedly a secret meeting between lenders and the Department of Finance (DoF). Sources tell the Spy that regulators indicated a preference to see mortgage rates rise, and were prepared to keep tightening regulations to make that happen.

It’s not clear if a specific rate target was set out by the DoF. What officials did reportedly indicate, according to my sources at that meeting, is that their plans (stricter capital requirements, securitization limits, insurance rules, etc.) will raise lenders’ funding costs and that is desirable. Regulators reportedly suggested that their policies could jack up rates more than 75 bps with minimal ill effect on borrowers.

Make no mistake. What we’re dealing with here is a stealth rate hike.

If Bank of Canada Governor Stephen Poloz can’t drive up Canadian interest rates, it looks like federal policy-makers are going to do it for him. And that’s going to cost you megabucks in mortgage interest.

Let’s hope the benefit (a more stable housing market) is truly worth it. Only 1 in 357 borrowers default as it is. 

Moreover, let’s hope that housing stability is the actual outcome here, not the opposite. I can tell you one thing for dang sure. There’s going to be a lot of home sellers moving up their sale plans when they realize what just happened.

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  • Avid Reader says:

    I think the government may have acted a little too aggressively with this latest change. Did something need to be done? Of course. The current trajectory of the house prices in certain key markets is clearly unsustainable. Will this latest round of changes trigger a soft (or worse) landing across the country (and not just in the two markets that needed to be cooled the most)? Well, time will ultimately tell, but my hunch is yes.

  • Tara S says:

    The fallout is going to be interesting…

  • WayneK says:

    Housing stability is a worthy goal but we need housing stability at a reasonable cost, not housing stability at all costs.

  • Dianne Chafe says:

    Lets hope all of the mono line lenders come together to fight this. Taking competition out of the market is never good for anyone. Notice how they never address interest rates on credit cards and how easy it is to get one!!

  • Richard Keena says:

    I personally applaud the government for taking the necessary steps to bring Canada’s runaway real estate market back under control. Would it be preferable to let the market run up even further to, say$3M for a house in Vancouver? Give your heads a shake. How is that sustainable? It may still be too late, but at least the government is going something tangible to avoid what would have been a very serious housing crash.

    • The Spy says:

      Richard, Canada doesn’t have a runaway real estate market. Toronto and Vancouver have a runaway real estate market (and Vancouver’s is already coming in). Something must be done, yes. But show me one middle-class Canadian who is buying a $3 million house. The problem is that these rules are targeted at the wrong people. A bad rule is not better than no rule at all. There are far better ways to address overvaluation in specific markets — ways that don’t drain the wallets and home equity of 20+ million Canadians.

  • Dev says:

    Spy a question for you?

    IS it going to effect HELOC qualification?

    • The Spy says:

      Remember that these are changes to insured mortgages. HELOCs are not generally insured.

      Some lenders insure the amortizing portion (like a 5-year fixed component, if the borrower has one). But lenders can never insure the revolving credit line portion.

      Also, most lenders already qualify HELOCs on a 25-year amortization. So an amortization reduction to 25 years won’t matter much either.

      All in all, very little impact on HELOCs industry-wide.

  • Steve says:

    If Government consulted industry-types prior to these announcements (which, to my understanding, they weren’t), what would industry have said in objection to the rules changes?

    “There are far better ways to address overvaluation in specific markets…ways that don’t drain the wallets and home equity of 20+ million Canadians.”

    Why should the small market in Arnprior suffer because of the hands (read: wallets and pockets of the many indebted Canadians) from two metropolitans?

  • The Spy says:

    Steve, Fair question, thanks.

    They might have suggested boosting qualification standards at all lenders and on all borrowers fairly and equivalently. That could have entailed things like mitigating risk further on high-priced homes, those with high debt ratios, serial refinancers, folks with weaker credit and those with less than 10-20% down. There are truly so many options. It would have just taken regulators a few months of consultation and some honest effort to come up with something superior to what Canadians got.

  • MUKESH says:

    Those who book their house with a higher price considering that they will get sufficent mortgage after 20 to 30% down payment.Now they will be approved insufficiant mortgage. e.g.If i buy 620000 house with 30% down about 200000 considering will be approved about 400000 mortgage. Now according to new rule if that person has to close his house by the end of 2017 he will be approved about 330000 to 350000 only, then he will be short about 50000 to 70000 to close the house.

    • The Spy says:

      Hi Mukesh, If you have already signed a legally binding purchase agreement and qualify for a mortgage before November 30, essentially nothing changes for you.

  • King Henry VIII says:

    So let me get this straight. The government has introduced these new measures in an effort to cool the housing market and make it more affordable so first-time buyers can enter it, by introducing stricter qualifying rules which will make it more difficult for them qualify for a mortgage…

    Seems about right.

  • Steve Balsam says:

    I am a renter (and prospective home-buyer) in Toronto trying to understand the potential impact of the new rules. It is my understanding that the new rules are intended mainly to impact the housing markets in Toronto and Vancouver. Given that single family homes in those cities are priced above $1 million, how will the new rules actually impact lending for such home purchases? I thought insurance was already precluded for home purchases over $1 million under the prior set of rules. Is that correct, or were lenders able to purchase portfolio insurance on such $1M loans that they made to individuals? Thanks for all your work in helping us understand what is going on. Steve

    • The Spy says:

      Hi Steve,

      Up till now, lenders have been able to insure $1 million+ properties as long as the borrower had 20%+ equity. It’s only high-ratio mortgages that can no longer be insured on million-dollar properties.

      Effective, Nov. 30, lenders will lose the ability to insure all properties over $999,999.99. That’s going to reduce those borrower’s options to lenders who don’t need to securitize. This will, in many cases, result in higher mortgage rates/or and worse mortgage products (e.g., higher-penalty mortgages) for those borrowers.


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