It’s a simple question; in theory, at least.
And your answer cannot possibly be unbiased, and influenced by whether or not you own property, where you live, and a host of other variables.
I’d like to get a well-thought-out discussion going, not only on whether or not to cool the housing market, but also how.
Let’s look at Norway as an example…
Raise your hand if a larger percentage of your personal net worth has come from a tax-free capital gain on your primary residence, than that which has come from generating income from your occupation.
Is your hand raised?
You can see right off the bat how answering the question, “Should government take steps to cool the housing market” all depends on where you’re currently standing.
I’ve been hearing about the “collapse in the housing market” since I got into the business in 2003, and as I always like to muse, “The media has accurately predicted eight of the last two recessions.”
But the more our Toronto real estate market keeps gaining, the more we hear about possible government intervention to artificially cool the market down.
It would be artificial, right? If Jim Flaherty decided tomorrow that from now on, buyers must have a 20% down payment on a house or condo, and the market cooled as a result, that would be considered an “artificial” cooling, would it not?
There are some who believe that government should have a role in this. Governments use fiscal and monetary policy to regulate the economy; injecting money through spending to stimulate the economy, and raising interest rates to try and take money out of the market by encouraging consumers to save, and/or making it more difficult to borrow.
So let me ask the question again: should the government take steps to cool the housing market?
They have tried before…
In the last couple years, we’ve seen the following significant changes:
1) Minimum 5% down payment. I remember the days of 107% financing…
2) Minimum 20% down payment for second properties. We don’t want people running around and buying eight condos with 5% down, let alone at 107% financing…
3) Minimum 20% down payment for any property over $1,000,000. Shouldn’t million-dollar-buyers have minimum standards?
4) Reduction in amortization period from 40 years to 25 years. Pay off the mortgage faster, and pay less interest…
5) Qualification for all borrowers at a 5-year, fixed-rate, with a 25-year amortization. This gives them a bit of a buffer in case things change…
Did these changes do anything to cool down the market?
Not really, in my opinion…
So what is a finance minister to do?
A recent article in the Globe & Mail uses Norway as an example of how some countries’ financial regulators are “letting the air out of the housing bubble.”
(thanks to the online newspapers no longer allowing access, I can’t find the article online – but it’s titled “Norway Lets The Air Out Of Its housing Bubble,” by Saleha Mohsin)
Two excerpts I wanted to share:
“When it comes to residential property, Norway is among countries such as Canada, Australia, and Switzerland considered “high-flyers” in the past few years, according to Goldman Sachs Group Inc. These markets have benefited from robust recoveries as well as a significant dose of “inadvertent” monetary policies from the world’s largest central banks. Norway has seen some of the most dramatic increases, with house price gains of close to 30% since the first quarter of 2009.”
“Surging Norwegian prices, driven by low borrowing costs, have helped fuel consumer debt to twice-disposable incomes, prompting warnings from policy makers and economists that the development is unsustainable. In response, regulators introduced measures to cool demand, including capping loan sizes at 85% of a property’s value as well as higher capital requirements and risk weights on mortgages.”
Already, Norway has seen housing prices slide 1.5% in October from a month earlier, as per the article.
So we know that regulation can work, but only if extreme measures are taken.
I’d say that raising the minimum down payment for all borrowers to 15% would be extreme.
So if you answered “no” to the question: should the government take steps to cool the housing market, I’d like to know why.
If you’re a property owner, why would you want the housing market to cool? Chances are – your house has been rising in value ever since you purchased, so why kill the Golden Goose?
Unless you’re thinking about the “greater good” for the housing market, and the economy, I’d be surprised to hear that a current property owner wants the housing market to cool.
And if you’re not a property owner, of course you want the market to cool! You’re frustrated beyond belief with the cost of real estate in Toronto! You’ve become a real estate bear out of necessity because you NEED to believe that the crash is coming!
So try, for a moment, to take your own personal situation out of the equation.
Should the government take steps to cool the housing market?
If they should do so, I have five potential steps that finance minister Jim Flaherty should consider, of course, not all at once…
1) Raise Minimum Down Payment to 10%
From now on, lenders will only loan to a maximum of 90% of the property’s value.
This not only reduces exposure for the lender, in case the property decreases in value, but it also reduces the debt load on the borrower, and causes him or her to pay less interest.
This would probably have the largest effect at the lower end of the market, where first-time-buyers are spending $15,000 to purchase $300,000 condos. It would probably make the market feel a bit better to know that these people, many of whom are in their early 20’s, have $30,000 into the property instead.
With only a 5% down payment, many buyers risk “going underwater” on their properties if the values decrease.
Think about it: you probably have no problem dealing with the price volatility in your stock portfolio. If you owned shares of Research in Motion, you’re used to 5-10% ups and downs. I know the market has had a booming 2013, but in more realistic times, we’re all accustomed to seeing stocks go up and down, and up and down.
But when it comes to real estate, a 5% dip in the price of a property could completely wipe out a person’s equity.
Should we force buyers to provide a higher down payment? Should we ensure banks don’t continue to lend to 95% of value?
2) Make Borrowers Qualify At A Higher Interest Rate
The current variable rate mortgage is approximately 2.70%.
The current 5-year, fixed-rate mortgage is 3.49%.
Borrowers typically have to qualify based on a 5-year, fixed-rate mortgage with a 25-year amortization, even if they’re going with a variable rate at 2.70%.
But what if we took that a step further?
What if buyers had to qualify based on a 10-year rate?
We’re giving them 25-year amortizations, right? So how come they only qualify based on 5-year outlooks? What if interest rates are at 9.79% in 2018 when they go to renew?
Maybe building in a “buffer” would help protect the consumer from him or herself.
3) Raise Interest Rates
This is not an easy solution, and not one that can be utilized to cool the housing market, without having a massive effect on every industry, every business, and every person in Canada, not to mention the financial markets.
I only include this in the list because “raising rates” is so often suggested as a way to cool the housing market, as if it only applied to the housing market, and nothing else.
Is there a way to raise the interest rate for mortgagees, without changing the overnight lending rate?
4) Tighten Lending Guidelines On Multi-Unit Dwellings
A 4-unit property will likely still qualify for “conventional” financing, ie. a 20% down payment.
A 5-unit property will almost undoubtedly require a 30-35% down payment.
A 6-unit property or more, will not only require a 35% down payment, but will also likely require a commercial mortgage rate.
I’m not going to suggest that a duplex should require a minimum 20% down payment, but maybe something can be done to tighten lending practices when it comes to multi-unit dwellings.
Many lenders don’t need any proof of income or copies of leases for multi-unit dwellings. They simplly need the 20% or 35% down payment (depending on the size of the building), and they’re off to the races.
Perhaps the income derived from the property should factor in to the loan equation.
5) Privatize the CMHC
This idea will go over really well with a LOT of people!
Every time I talk to somebody who has 40-50% equity (or more) in their home, they say, “I wish the CMHC wouldn’t insure all these goddam high-ratio mortgages, and but a massive burden on the taxpayers. Some kid wants to buy an over-priced condo with 5% down, and the public has to take on the risk?”
As of March 31, 2013, CHMC’s insurance-in-force was $562,600,000,000, representing an insurance risk of approximately $17,000 per Canadian. (Source: Wikipedia)
Some say that’s not fair to each individual in Canada.
Some say that this is the way government operates, and it’s no different than the government offering free healthcare.
But I have to think that if the CMHC no longer directly “threatened” every person in Canada, then a lot of housing bears would ease up.
Perhaps some of these ideas could be put into play.
Or all of them.
Or none of them.
It depends on whether or not the government should let the free market ride, or whether they should intervene.
Every day, I see more and more articles on the housing market and how it continues to rise, but that’s nothing new. I also see more and more predictions of a decline, but that’s not a new idea either. I’ve been seeing the same predictions for a decade, all the while, the market has continued to rise.
Is that why we need government intervention?
I’ll be honest – I’m on the fence.
But I’d like to hear from all of you…