The 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.
Mortgage 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:
- 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
Regulators 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.