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Last week the Bank of Canada (BoC) issued its latest Financial System Review, giving us the Bank’s assessment of the “the main vulnerabilities and risks to the stability of the financial system”.
In this latest report, the BoC highlighted “the elevated level of household indebtedness and imbalances in some regional housing markets”, specifically Vancouver and Toronto. The Bank cautioned that “rapidly rising house prices and strong mortgage credit growth are increasing the share of highly indebted households” and warned that “it is unlikely that economic fundamentals will justify continued strong price increases.” The Bank cautioned that prospective buyers in Vancouver and Toronto “should not extrapolate recent real estate performance into the future when contemplating a transaction.”
Not much to argue with there. Purchasers are having to take on more and more mortgage debt as homes in Vancouver in Toronto become more expensive, and the resulting higher debt levels make households more vulnerable to financial shocks. Also, the continued rise in house prices increases the risk that purchasers will base their decision to buy on unrealistic assumptions about the potential for additional gains.
Despite these concerns, the BoC gave no indication that it plans to raise interest rates to try to reign in the rise in household debt levels or to help cool regional housing markets. Instead, the Bank is hoping that the federal government will consider making more changes to its residential mortgage-lending regulations, which can be more specifically targeted at the areas of concern.
Federal Finance Minister Bill Morneau recently confirmed that the government is doing a “deep dive” on the issue, so more regulatory changes can be expected. The key question now is “what changes will our federal government actually make?”
The answer seems pretty clear to me. If fully extended borrowers in the Toronto and Vancouver markets are the main areas of concern, adopting a more rigorous qualifying standard for high-value properties is the most effective way to help mitigate this risk.
Specifically, I think that our federal government should require anyone purchasing a property valued at more than $1 million to qualify using a maximum amortization period of twenty-five years (today these borrowers can qualify using amortizations of up to thirty-five years).
This change would have the most significant impact on the most expensive housing markets, and would only impact high-end buyers. By reducing the maximum amortization period that is used to qualify these specific borrowers, our regulators would be making it harder for the most stretched borrowers to buy in the upper-end of the market, the segment which is most typically vulnerable to house-price corrections.
To be clear, I think that borrowers who can qualify under this tougher standard should still have the option of setting their payments using amortizations of thirty or even thirty-five years. This will allow them to gain more flexibility over the term of their loan by lowering their minimum contractual payments, creating a cash-flow buffer for their mortgage payments. In my experience, borrowers who use extended amortizations for this purpose can, and do, use their discretionary mortgage-prepayment allowances to achieve shorter effective amortizations, so opting for an extended amortization does not necessarily mean that borrowers will end up taking longer to pay off their loan.
Our federal government has made four rounds of changes to the rules used to underwrite our residential mortgages over the past several years, so we have been down this road before, and in hindsight, those changes all proved prescient. But there is added uncertainty this time around because we now have a new federal government that has not yet spoken on this issue. Here’s hoping that they consider the change outlined above if they determine that further mortgage-rule changes are needed.
Five-year Government of Canada bond yields fell another three basis points last week, closing at 0.58% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.59% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at around 2.59%.
Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: The BoC has highlighted rising household debt levels and continuing Vancouver and Toronto house-price appreciation as two of the three most significant risks to our financial stability. This makes it increasingly likely that our federal government will make more changes to the rules used for residential mortgage underwriting and, if they do, I think the change proposed above makes the most sense.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave
June 13, 2016Mortgage |