How Federal Policy Mishandled Mortgages – Part 1

Essay, Housing Affordability, Lee Harding

The federal government has made misguided mortgage policies in recent years. The first, in 2015, was to raise the amount that Canadian Mortgage and Housing Company (CMHC) mortgages required for a down payment. The second, in 2016, was to increase the stress test. The third, in 2017, was that the mortgage stress test would be based on rates roughly 2% higher than their potential contractual rate. The fourth, in 2019, was to create the First-Time Buyer’s program. The fifth came quite recently in the form of more rule-tightening by CMHC. By taking the steps that it did in the order that it did, the government has brought about bad results for the Canadian economy and public. This essay covers the first three of these changes, while a sequel will address the final two.

CHANGE ONE: INCREASED DOWN PAYMENT

When a mortgage in Canada is worth more than 80 percent of the home’s value, it has to be insured by Canada Mortgage and Housing Corporation. Until 2016, this allowed people to put as little as five percent down on their mortgages. On December 11, 2015, Federal Finance Minister Bill Morneau announced that starting in 2016, CMHC would require a 10 percent down payment on the portion of any mortgage it insured over $500,000.

Morneau told the CBC, “We recognize that, specifically in the Toronto and Vancouver markets, we have seen house prices that have been elevated . . . and we want to make sure we create an environment that protects the people buying homes so they have sufficient equity in their home.”1

If this was the goal, the effort was misdirected. CMHC does not offer any coverage for mortgages over $1 million. For that reason, many properties in the Toronto and Vancouver area would escalate as much as ever. CIBC economist Benjamin Tal said only 2.5 percent of sales in Vancouver and 5 percent in Toronto would fit that $500,000 to $1,000,000 range. By contrast, almost 10 percent of new home sales in Calgary would be affected, as would 6 percent of homes in Edmonton.2

Canadian Mortgage Professionals (CMP) opposed the change because it would lower sales. It issued a statement that read, “Until a year ago, the oil sector and housing market were the leading contributors to job creation in Canada. With one of these two leaders now increasingly hobbled, this is not the time to deliberately hobble the remaining economic leader.”3

Frontier Centre for Public Policy author Wendell Cox has argued that provincial and municipal land-use regulations are a greater contributing factor to escalating prices. As evidence, detached houses are preferred by most buyers. Cox’s analysis of the Altus Cost Guide in 2016 showed that building costs for such a house in Vancouver were only 25 percent more than in Edmonton. Even so, the cost of buying a home like this in Vancouver was four times that of Edmonton. The federal government’s move only served to kneecap prices in an area facing economic hardship, leaving the challenges of market demand and land use policies intact.4

Shortly before the federal government released its next move, the headline from CBC online read, “Average Canadian home cost rises 9.5% to $474,590 in September” with the subtitle “Hot markets in Toronto, Vancouver continue to push up prices.”5

CHANGE TWO: EXPANSION OF THE STRESS TEST

The second change came in October of 2016. Mortgage insurance rules had required that lenders “stress test” a borrower’s ability to make their mortgage payments at a higher interest rate. Previously this was only required for insured mortgages with variable interest rates or fixed rates with terms of less than five years. Going forward, it would cover all insured mortgages. 6

Also, the same loan eligibility requirements that previously applied to mortgages that were for over 80 percent of the mortgage value would now apply to mortgages of 80 percent or less. This was the Bank of Canada’s conventional five-year fixed posted rate.7

The government backgrounder explained it this way:

Lenders and mortgage insurers assess two key debt-servicing ratios to determine if a homebuyer qualifies for an insured mortgage:

  • Gross Debt Service (GDS) ratio—the carrying costs of the home, including the mortgage payment and taxes and heating costs, relative to the homebuyer’s income;
  • Total Debt Service (TDS) ratio—the carrying costs of the home and all other debt payments relative to the homebuyer’s income.8

To qualify for mortgage insurance, a homebuyer must have a GDS ratio no greater than 39 percent and a TDS ratio no greater than 44 percent. Qualifying for a mortgage by applying the typically higher Bank of Canada posted rate when calculating a borrower’s GDS and TDS ratios serves as a “stress test” for homebuyers, providing new homebuyers with a buffer to be able to continue servicing their debts even in a higher interest rate environment, or if faced with a reduction in household income.

The Bank of Canada’s five-year standard rate was 4.64 per cent at that time, an amount that was higher than what many lenders had been offering. 

Toronto broker Marcus Tzaferis told the CBC, “I think that we will see first-time homebuyers begin to get frustrated after the rule comes in . . . It’s a pretty significant hit to how much people can afford — you’re looking at 20 to 30 percent reduction in the mortgage value that people take on.”9

CHANGE THREE: TWO PERCENT AUGMENTATION OF THE STRESS TEST

On October 17, 2017, exactly one year from change number two above, the Office of the Superintendent of Financial Institutions Canada (OSFI) revised its guidelines. Effective January 1, 2018, Guideline B-20 required “the minimum qualifying rate for uninsured mortgages to be the greater of the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate +2%.”10

By then, the Bank of Canada five-year benchmark was 4.89 percent, meaning that potential buyers needed to prove they could afford a mortgage with at least a 6.89 percent rate in order to get a mortgage that would be at least two percent less.11

Robert McLister, the founder of mortgage broker intelliMortgage.com, commented that OSFI “hasn’t just ‘tapped the brakes,’ it’s jumped on the brakes with both feet.”12

Paul Taylor, President and CEO of Mortgage Professionals Canada said he was “disappointed” with the new stress test and added, “I believe the new qualifying rate will have negative implications for the Canadian mortgage finance market and the national economy as a whole.”13

The mortgage comparison website RateHub.ca showed what the impact would be. A family who earned $100,000 and put a 20 percent down payment on a 3.09% five-year fixed-rate mortgage amortized over 25 years could have qualified for a house worth $706,692. The new stress test left them unable to afford anything above $559,896.14

By February of 2019, real estate agents were wishing the two percent stress test was gone. Christopher Alexander, executive vice-president and regional director of RE/MAX INTEGRA, Ontario-Atlantic Canada, could already write by February 2019 that the two percent stress test should be revoked, especially since the rise in interest rates (that the two percent buffer was supposed to cushion for) was not going to happen.

Ten percent of Canadians no longer qualify for a mortgage with banks. The stress test has cut first-time homebuyers out of many markets in Canada and caused a ripple effect through every tier of homebuyer. It has affected move-up buyers needing larger homes to accommodate growing families. It has created a frenzy in the rental market, since those who no longer qualify for a mortgage are opting to rent. . . . 

Being in the industry myself, perhaps my stance sounds self-serving. But the fact is that real estate continues to be one of the safest and most reliable financial investments for Canadians and first-time buyers deserve an opportunity to enter the market.15

Alexander concluded that whatever merit the stress test had early on, the two per cent level was “unproductive now that the market has normalized to more reasonable levels.” Yet, it remained.

Instead of removing the stress test, its next move to “help” Canadians was even more government intrusion—the first-time buyer’s program. This change moved first-time homebuyers to buy into a housing bubble with the government itself becoming part owner of the home. Changes four and five will be addressed in the sequel to this essay.

 

”SeeEndnotes”

  1. “Bill Morneau Tightens Mortgage Rules on Homes over $500K,” CBC, December 11, 2015, https://www.cbc.ca/news/politics/morneau-home-ownership-finance-1.3360610.
  2. “Canada’s New Federal Mortgage Rules: Right Diagnosis, Wrong Medicine?,” Frontier Centre For Public Policy, May 3, 2016, https://fcpp.org/2016/05/03/canadas-new-federal-mortgage-rules-right-diagnosis-wrong-medicine/.
  3. https://www.cbc.ca/news/politics/morneau-home-ownership-finance-1.3360610
  4. https://fcpp.org/2016/05/03/canadas-new-federal-mortgage-rules-right-diagnosis-wrong-medicine/
  5. “Average Canadian Home Cost Rises 9.5% to $474,590 in September,” CBC, October 14, 2016, https://www.cbc.ca/news/business/crea-house-prices-1.3804718.
  6. Department of Finance Canada, “Archived – Backgrounder: Ensuring a Stable Housing Market for All Canadians – Canada.Ca,” Canada.ca, 2016, https://www.canada.ca/en/department-finance/news/2016/10/backgrounder-ensuring-stable-housing-market-all-canadians.html.
  7. Department of Finance Canada, “Archived – Technical Backgrounder: Mortgage Insurance Rules and Income Tax Proposals (Revised October 14, 2016) – Canada.Ca,” Canada.ca, 2016, https://www.canada.ca/en/department-finance/news/2016/10/technical-backgrounder-mortgage-insurance-rules-income-proposals-revised-october-14-2016.html.
  8. Department of Finance Canada, “Archived – Technical Backgrounder: Mortgage Insurance Rules and Income Tax Proposals (Revised October 14, 2016) – Canada.Ca,” Canada.ca, 2016, https://www.canada.ca/en/department-finance/news/2016/10/technical-backgrounder-mortgage-insurance-rules-income-proposals-revised-october-14-2016.html.
  9. “New Mortgage Stress Test Rules Kick in Today,” CBC, October 17, 2016, https://www.cbc.ca/news/business/mortgage-rules-stress-test-1.3808140.
  10. Office of the Superintendent of Financial Institutions, “OSFI Is Reinforcing a Strong and Prudent Regulatory Regime for Residential Mortgage Underwriting,” Osfi-bsif.gc.ca, 2019, http://www.osfi-bsif.gc.ca/Eng/osfi-bsif/med/Pages/B20_dft_nr.aspx.
  11. “OSFI Unveils New Stress-Test Rules – Mortgage Rates & Mortgage Broker News in Canada,” Mortgage Rates & Mortgage Broker News in Canada, October 17, 2017, https://www.canadianmortgagetrends.com/2017/10/osfi-unveils-new-stress-test-rules/.
  12. Ibid
  13. Ibid
  14. Ibid
  15. Christopher Alexander, “The Mortgage ‘Stress Test’ Has Started Harming Canadians More than It Helps,” (Financial Post, February 26, 2019), https://business.financialpost.com/opinion/the-mortgage-stress-test-has-started-harming-canadians-more-than-it-helps.

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Lee Harding is a research associate with the Frontier Centre for Public Policy.