Should You Stress Over The New Mortgage Stress-Test?

I honestly don’t think that people would be so worried, anxious, stressed, jittery, frazzled, concerned, tense, hassled, or any other synonym for stress, if the associated test itself had a different name.

If this was called the “Financial Lending Life Pattern Guideline,” instead of mortgage stress test, I really don’t think we’d be having the same conversations.

In any event, after a long week, I had planned to regale you with some Photos of the Week, but I knew one or two readers would say, “I expected more from you, David,” and I didn’t want to be reminded of the first time I was ever with a girl.

Sooooo……let’s have a brief conversation about this week’s OSFI changes, and tell you about the TRB Q&A I have planned for next week on the topic…

StressTest

First order of business, folks: tell me why OFSI implemented this new stress-test.

Was it:

a) An attempt by the government to reign in borrowing among Canadians.
b) An attempt to cool the housing market.

Geez, on that question alone, we could argue all day.

I’ve said it before, and I’ve said it again: the government has spent the better part of the last decade changing policy in attempts to cool the housing market.

I’ve also provided this list, or some version of it, many times before, but since the U.S. housing crisis in 2008, we’ve seen the following major changes to the Canadian mortgage market:

*Eliminating 107% financing and other products that require no down payment, and offer money back on closing

*Instituting a minimum 5% down payment rule (from 0%, or negative down payment, as above)

*Eliminating the 40-year amortization

*Eliminating the 35-year amortization

*Instituting a minimum 20% down payment rule for second properties, ie. investment, or non-primary residence

*Increasing the downpayment for purchases over $1,000,000 to 20%

*Ensuring all borrowers qualify at the 5-year, fixed-rate mortgage on a 25-year amortization (this was a precursor to stress-testing)

*Increasing CMHC insurance premiums

*Increasing the downpayment for the portion of purchase price from $500,000 – $999,999 from 5% to 7.5%

*Creating a “stress test” for insured mortgages, ie. those under $1,000,000.

All those changes, and nothing cooled the market.

What did cool the market?

The Ontario Fair Housing plan this past April, or, at least the timing of the plan did.

There are still those among us, myself included, who believe that the main reason that the market cooled after April was because of the unprecedented rise in home prices from January to April.  The contents of the Ontario Fair Housing Plan didn’t really have an effect on the market, since only the point about the Foreign Buyer’s Tax had any real teeth, but the sight of politicians standing in front of podiums, talking about cooling the market, was ultimately what cooled the market.

So here we are, a half-year later, and we’re still talking about cooling the market.

Except this time around, the chatter about the Office of the Superintendent of Financial Institutions (OSFI) spearheading the “mortgage stress-test” has nothing to do with cooling the market, and everything to do with reducing debt-loads among Canadians, and somehow “strengthening” Canadian financial institutions.

So again, I ask, is this really the objective?

Because so many times in the past, the CMHC has instituted measures aimed at cooling the market, but announced as measures to “reduce debt” or some other rhetoric.

Before we go any further, perhaps I should outline the OSFI policy changes for those not in the know.

You can read the entire release HERE.

The title of the release reads:

OSFI is reinforcing a strong and prudent regulatory regime for residential mortgage underwriting

I love how carefully the wording is chosen.

It doesn’t say “creating” a strong and prudent regulatory regime, or “implementing.”

It says “reinforcing,” which is essentially implementing new policy, while patting yourself on the back for the old one.

There is no mention, anywhere, of “cooling the market,” nor will there be.

It would seem, at least this time around, that these changes really, truly, for perhaps the first time, are aimed at lending practices.

Here’s the bulk of the release:

The changes to Guideline B-20 reinforce OSFI’s expectation that federally regulated mortgage lenders remain vigilant in their mortgage underwriting practices. The final Guideline focuses on the minimum qualifying rate for uninsured mortgages, expectations around loan-to-value (LTV) frameworks and limits, and restrictions to transactions designed to circumvent those LTV limits.

OSFI is setting a new minimum qualifying rate, or “stress test,” for uninsured mortgages.

Guideline B-20 now requires 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%.

OSFI is requiring lenders to enhance their loan-to-value (LTV) measurement and limits so they will be dynamic and responsive to risk.

Under the final Guideline, federally regulated financial institutions must establish and adhere to appropriate LTV ratio limits that are reflective of risk and are updated as housing markets and the economic environment evolve.

OSFI is placing restrictions on certain lending arrangements that are designed, or appear designed to circumvent LTV limits.

A federally regulated financial institution is prohibited from arranging with another lender a mortgage, or a combination of a mortgage and other lending products, in any form that circumvents the institution’s maximum LTV ratio or other limits in its residential mortgage underwriting policy, or any requirements established by law.

I know you didn’t read the second two points.

You saw the figure, +2%, and a bell went off, as if to say, “I have heard about this.”

Yes, it’s a stress-test, much like the one that was brought into effect two years ago, for insured mortgages.

That policy change had absolutely zero effect on the market, much like the previous policy changes.

I remember doing a spot on CTV the day those changes came out, and the question posed to me was not, “Will this stress-test have an effect on the market?” but rather, “How much of an effect will this new stress-test have?”

Everybody had already made their minds up.

This time around is no different.

Don’t get me wrong – this isn’t going to help the residential real estate market!  But is it going to cause it to crash?  I think you all know me too well for me to even answer that…

I know, I know – the bears are digging their claws deep into the linoleum tile of their rental apartment right now, predicting Armageddon.

But there’s one thing people need to remember about mortgage pre-approvals from before this new stress-test was announced: they were always for more than buyers wanted to spend.

One of the recurring themes over the last few years, specifically, I’d say, the past five, is that most of my buyers get pre-approved for more money than they want to spend.

My buyers will tell me in our first interaction, “We’re looking to purchase for about $1.1M, maybe a bit more if we find the perfect house.”

Then a week later when we meet at a property, and I ask them if their mortgage pre-approval was completed, they’ll say, “Yeah, it’s crazy – the bank approved us for $1.5M, which is just crazy!  We don’t want to spend that!  I don’t think we could afford that!”

Time and time again, I’ve heard this story.

So when I read the headlines in the newspapers, that “….buyers will be able to afford 20% less than they would have before the stress-testing,” I think to myself, “So what?”

If they were being approved for amounts they didn’t want to spend in the first place, then what’s a 20% reduction?

Well, that sounds like I’m putting a really positive spin on this, doesn’t it?

Fair point, even though I’m the one arguing it, on the readers’ behalf.  But I can see just how biased that must sound – me trying to defend the almighty real estate market, in the face of great calamity.

do think there’s going to be fallout from the stress-testing, and there are going to be buyers who wanted a $2.2 Million house, who were stretched to the absolute max, that can now only afford a $1.8 Million house.  But those buyers are not the norm.  In my experience, and I sell about 25 properties over $1M per year, maybe 1-2 of those buyers are stretching to the absolute max.  That will have an impact, but not nearly what’s being reported in the media.

Ah yes, the media reports!  They’re eating this up, aren’t they?

When I read, “…..affordability is down 20%,” I think it’s irresponsible.

There’s these insinuations in the newspapers that as a result, home prices will drop 20%.  And you just know that’s how a lot of people want to read this.

But there’s no direct correlation between a reduction in the pre-approval amount of a would-be buyer over $1,000,000, and the decrease in average home price.

As I said, many buyers won’t be affected, as they won’t want to spend whatever the banks were pre-approving them for.

And how many of these buyers will now end up going to unregulated lenders?  HERE is a great article on that subject, which deserves a read.

The Fraser Institute released a study last week suggesting that the mortgage stress-test is “unnecessary” and “harmful.”  You can read that article HERE too.

But personally, I don’t think it’s bad policy.

Unnecessary, perhaps.  But it’s not a bad thing.

I don’t believe interest rates are going to double any time soon, nor do I even think they’ll be up a full 100 basis points in the next 18-24 months.  I just don’t see it happening.

But Canada has always been viewed as having one of, if not the best banking system in the world.

And if that’s the case, then I’m ready to simply go with the flow.

Just think about that for a moment.  There are 195 countries in the world, and wee little Canada, of all places, is at the top of the banking hierarchy.

The World Economic Forum ranked Canada’s banking system the “World’s Soundest” for a staggering eight years in a row, from 2008 to 2015 inclusive.  Alas, we were ranked third in 2016, and second in 2017.

Eight years in a row.  That’s incredible.  That’s like Lance Armstrong in the Tour de France!  Wait…..well…ummm….

….anyways.

So you know what?

I’ll be the last one to complain about this policy change.

Perhaps it’s progressive.  Perhaps it’s protective.

Either way, it’s not a bad thing.

So now let’s talk about the effect it’s going to have, notably where, who, how, and then of course – what are the unintended consequences?  Yes!  there are always unintended consequences!

Next week, I’m going to sit down with my mortgage broker, Joe Sammut, and answer any questions you guys may have about the new OSFI policies.

Feel free to write your questions in the comments section below, email me, Tweet me, or send it over Instagram with a photo of your $45 lunch from a place I would never go to.

If you have questions, let me get you answers from an expert.

I’ll film next week, and have it up for Wednesday.

Have a great weekend, everybody!

69 Comments

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  1. DavidNotFleming says:

    David did have a point, didn’t we already have stress testing in place for insured mortgages, and several news outlets had already predicted how the stress test would have negatively affected demands since it would reduce the ‘purchasing power’ of borrowers?

    http://archive.is/6A5RF

  2. T says:

    A lot of delusional discussion on this blog. Over the last year this blog has gone from informative to a constant debate on real estate as an investment.

    On one side you have those who think you should be able to just buy property with debt, sit on it, and get rich.

    On the other you have those whom understand markets and investment fundamentals, whom actually look at all data and trends and understand risk. They can chart actual ROI including all expenses and opportunity costs, not just what a house is worth today vs yesterday.

    Neither side will ever be able to convince the other they are right. Each side believes their views are ‘common sense’.

    Speaking of common sense, everyone needs to come to terms with the following:
    – average people buy average priced properties
    – average prices fall as average people’s purchasing power diminishes
    – cost of servicing debt is rising
    – taxes are increasing
    – utility costs are increasing
    – average pay is barely increasing at the pace of inflation
    – house prices have been supported by the average person’s ability to take on excessive debt at historically low lending rates

    And finally. All housing bubbles involved average and well off people taking on too much debt. We all know people who have taken on too much debt during the last cycle. Look around, open your eyes, it’s a sad scene. Millionnaires used to have million dollar houses. Now million dollar houses are owned by the eternally indebted, people who are barely making it paycheque to paycheque.

    How some realtors sleep at night knowing the kind of debt they are helping people get into, I don’t know. I guess as long as that commission cheque comes in, who cares, spread the poor financial advice.

    Houses only go up in value, and there are no costs associated with owning, right?

    1. Condodweller says:

      Don’t you try to bring reason and common sense into this! Seriously, the problem with this blog is that the one group you mention tries to mascarade as the other which I find is very dangerous for the average person and only feeds the herd mentality.

  3. David says:

    Hi,

    I bought a preconstruction home in Brampton, closing date is April, 2018. Should I sell my existing property now? I contemplate to list and sell in Jan. 2018 instead of now. I affraid home prices will drop after new osfi rules become effective in Jan., 2018.
    Thanks.
    David.

  4. steve says:

    I suspect there will be a psychological effect as well … where buyers expect prices to come down or stay flat for a long time. The FOMO will be replaced by a “meh” attitude, as people will appear more patient as they wait for the right property to come up for the right price.

  5. Devin says:

    I’ve recently signed a prebuild condo contract in Greater Vancouver, construction hasn’t begun yet and the completion date therefore financing is far into the future. Is there any indication of whether or not any type of contracts will be grandfathered to the old system, such as prebuilds? I’m curious (although I feel as I know the answer already…) If I am now subject to the new stress test when closing financing comes around…

    1. JCM says:

      Yes, you’ll obviously be subject to the new rules.

  6. JCM says:

    One year ago you could qualify for mortgage at a rate of 2%. Today it’s 5%. Do the math. This is a serious headwind — and it’s coupled with downward price momentum and higher interest rates.

    David’s anecdotal evidence is nonsense — economists for the big 5 banks say that 1 in 6 buyers in Toronto will be affected by the new regs. A significant percentage of buyers in Toronto in the last 18 months maxed out (or more!).

    Also, don’t forget about the new OSFI regulations regarding income verification. Lenders now need to see real evidence like CRA tax assessments. Sadly, that may actually be a bigger headwind than the stress test…

    1. Tina says:

      In the last 5 years TD has always asked to see our last two years notice of assessment.

    1. Kramer says:

      Amazing

    2. Drowzee says:

      Stocks performed even better: the S&P 500 went up about 1100% from 1981 to 2007 (roughly 125 to 1500).

  7. Professional shaker says:

    A segment of the market regardless of how small it might be, which I think the rule changes will have an impact is domestic spec and people with multiples properties used for rental if purchased recently using high leverage, this segment for sure could be at risk

  8. Condodweller says:

    I’m no mortgage broker but here are my thoughts:

    1. You only have to requalify if you want to increase the mortgage. Most mortgages are portable these days and you should have no problem porting an existing one.
    2. Switching shouldn’t be a problem, however, going to a new lender you will have to qualify. This was raised as an unintended problem as people will be essentially locked in with their current lender. How much of a deal do you think you are going to get from your bank when they know you can’t qualify elsewhere?
    3. Shouldn’t but this will be interesting to find out for sure because non-insured mortgages didn’t have to qualify at the fixed rates before therefore it’s possible you may not qualify if rates have gone up. I assume this is why you would want to lock in.
    4. Whenever you refinance you always have to qualify for the new amount.

    1. Condodweller says:

      This was a reply to Professional Shanker. This looks like a bug as I hit reply and others have had the same issue before.

    2. Condodweller says:

      This was a reply to Professional Shanker.

      1. Professional shaker says:

        Your response to #2 is scary as it gives a lender additional leverage in an environment it has too much already, this will be an unintended consequence which will need to be dealt with at some point if lenders abuse it too harshly for their benefit.

        The fall out from the regs are years down the road it seems

        1. Condodweller says:

          Anyone getting a mortgage going forward will be aware of this and can plan accordingly. The problem is going to be for people with existing mortgages coming due the next ten years once the new rules are in place who would not qualify again for their existing amount. They are going to be totally blindsided and will be at the mercy of their current lender who will no doubt offer them the posted rate or worse. The government needs to protect these people from unfair treatment.

  9. Appraiser says:

    David is absolutely correct that the cure for high prices is high prices, as was observed back in the spring. The April print from TREB indicating a 33% increase year over year, was the stat that broke this market’s back.

    We now have market over-reach met by regulatory over-reach.

    One was natural, the other wasn’t.

  10. Professional Shanker says:

    Dave, appreciate the perspective you bring regarding buyer’s not in the majority of cases using over 80% of their pre-approval amounts, this never would have occurred to me, as I would have expected a higher % using closer their pre-approved limit in the past couple years.

    I believe the effect will be quite large on prices, say 5% to 10% melt over a few years, but that remains to be seen and will be debated for years to come with no one really knowing the true answer as other factors will mask or negate the impact. Overall, the physiological impact of this change might very well be larger than the true mathematics of the lending change.

    What first time buyers and current homeowner’s would like to know is the actual real life impact, specifically I was hoping you can discuss the following with your MORTGAGE BROKER.

    1. If you are a move up buyer and are transferring your mortgage to a more expensive house – do you have to re-qualify under the new guidelines?
    2. If you recently purchased and are renewing with the same lender (say a 5 year fixed), then my understanding is that you do Not have to qualify under the new guidelines. What happens if you plan to switch lenders – do you have to qualify under the new guidelines?
    3. If you are currently under a variable rate mortgage and want to lock in, do the new lending standards factor in?
    4. Re-financing your mortgage – will the new guidelines have an impact?

    Thanks!

  11. Chris says:

    Kyle,

    There are definitely some bears who view it as a cult, just as there are some bulls who do. But I would hope we, David included, are above that. If he was joking about the rental linoleum floor, then it’s all good. If he was serious, however, that’s not a great way to refer to those who disagree with your opinion.

    To your second point, I haven’t been paying attention (or been bearish) for long enough to remember the implementation of all of these measures. However, you’re presenting each case as a discrete moment in time, when really, it’s an ongoing thing.

    To use Apple stock again, if someone was bearish on it’s valuation when it was at $120/share, unless the fundamentals change, I would expect them to continue to be bearish today when it is at $156/share.

    However, the stock market moves much more rapidly than the housing market. Research in the United States has found that the real estate market tends to cycle every 18 years.

    https://www.extension.harvard.edu/sites/extension.harvard.edu/files/foldvary-data.jpg

    So, if someone was bearish five years ago, and felt that 2012 Toronto real estate was overvalued, I would certainly expect them to continue to feel it is overvalued today. Real estate takes a long time to prove them right or wrong.

    1. Chris says:

      Meant as a reply to your post below, Kyle. Sorry.

      1. Kramer says:

        Chris, I was gonna post this to the other board to close off our last discussion but why not post it here as it applies…

        I 100% do not support median income or changes in median income or related ratios as appropriate TOP all-powerful fundamental metrics for the housing market… no more than I do than I do Average Income. I’ve explained why on many occasions and it the explanation is logical. If the population is increasing, but average or median income merely stays the same, you will still have MORE PEOPLE in the brackets who are able to afford a house, thus driving demand, with supply increasing extremely slowly.

        But here’s the thing… at this point, we have so much history of average/median income proving NOT to be the best/leading/top fundamental driver of this market. So why would you continue to prescribe to average/median income measures and ratios being the most important thing?

        I can picture someone in 2007 latching on to this, thinking it makes sense and never buying, and now being shut out for good. The question is, do they realize they were wrong 2007-2017 and consider that they still might be and look for different logical explanations? Or do they push on until they are eventually right?

        1. Chris says:

          Kramer,

          You are certainly correct in your assertion that as population grows, we have more people in all of the income brackets. However, if supply of homes for all of those income brackets is keeping pace (a debatable topic which we have touched on before), supply and demand should remain balanced, thus resulting in moderated price growth.

          In the 416, I can see why this has caused the price of detached homes to grow, as the supply of those is quite low. I don’t fully understand why condo prices are spiking though, given their high rate of supply, but that’s a whole different topic.

          However, in the GTA as a whole, there is quite a bit of supply of all home types, from condos all the way up to large detached homes (take a drive through Oshawa, Uxbridge, Oakville, Georgetown, etc.). As I’ve said before, I buy into the idea that the 416 should, and likely always will, be pricier. The 905 though, is an entirely different beast.

          It’s also part of the reason I don’t rely entirely on home price to income. Home price to rent is also a very valuable metric, as it isolates the true value someone places on living in a home (stripping out the premium they pay for the expected appreciation).

          Someone assessing the situation in 2007 should have realized that we were only 10 years out from the bottom of Toronto’s last real estate correction (prices started to re-climb around 1996-1997). Given the average cycle lasts 18 years, a rational person, particularly one who was looking for a home to live in rather than an investment, probably should have purchased. Even 10 years ago, the ratios I discuss were not that bad; affordability was decent (as charted by RBC), price to rent was alright. The picture isn’t quite so rosy today.

          1. Geoff says:

            Yay! I purchased in 2007. I wish I could say it was because I’m as smart as you guys. My son was born in 2007 and my one-room condo wasn’t gonna cut it and you tell a pregnant wife who’s endured pregnancy in a 3-story walkup that we’re gonna rent and maybe have to move in a year…. 🙂

        2. Ralph Cramdown says:

          “I can picture someone in 2007 latching on to this, thinking it makes sense and never buying, and now being shut out for good.”

          I can picture it too, but how likely is it? If you had the means (assets OR income) to buy in 2007, you should be wealthy today, whether you bought Toronto real estate and paid down the mortgage (REALLY rich if you pyramided) or bought other assets and kept investing. The bull/cheerleader faction likes to characterize people as being “on the sidelines” if they have the wherewithal to buy RE but choose not to, as if there’s only one game being played in one asset class, and you’re either “in the game” or invested in 0.5% GICs while your landlord bleeds you of the rewards of your production. NEWS FLASH: Most asset classes have done great in the last decade, successful renters are ten years further into their successful careers, and the only renters in this age bracket who are “priced out forever” are losers, comparable to the owners who bought ten years ago and used their RE equity to buy pricey vehicles and pay off their consumer lifestyle debts, and today carry bigger mortgages than when they bought.

          Everybody who could have bought Toronto real estate a decade ago (and who didn’t piss away all their money in the last decade) is rich, whether they bought or not. IMHO.

          1. Kramer says:

            Sorry, but you’re wrong.

            You can’t lever up on other asset purchases like you can with real estate.

            Your $40,000 downpayment on a semi-detached off the Danforth is now worth $440,000 if you bought in 2007.

            Your $40,000 downpayment invested into the S&P in 2007 is now worth $80,000.

            Furthermore owning the house is forced savings on the mortgage payoff. So you probably would have eaten more Kraft Dinners than $100 dinners on King St. rewarding yourself for being so conservative by renting.

          2. Chris says:

            Kramer,

            You’re right that you can’t leverage yourself to the same extent on equities as with real estate, but some quick math with my Questrade margin account shows that $40,000 in funds would allow me to lever up to about $140-150k. So not insignificant leverage.

            We should also remember that leverage amplifies both gains and losses. It is a double edged sword, and can wipe out your equity very quickly when it heads downwards.

            Finally, as to your forced savings plan, that is definitely true. The discussion of rent vs. buy is all predicated on the renter saving and investing the difference. If they piss it away on expensive meals, then they’re obviously going to fall behind someone with a mandatory mortgage payment (just as they’d fall behind a disciplined renter/saver).

    2. Kyle says:

      If one’s idea of fundamentals are consistently guiding them to the wrong conclusions time and again over many years. IMO it makes more sense to challenge one’s ideas of fundamentals before simply chalking it up to a slow moving market.

      1. Chris says:

        If one’s idea of fundamentals are consistently guiding them to the wrong conclusions time and again over many years. IMO it makes more sense to challenge one’s ideas of fundamentals before simply chalking it up to a slow moving market.

        Perhaps! But, as I’ve said in my bearish attitude, I make no illusions that I can predict the future. I feel that Toronto real estate is overvalued, and I perceive a number of headwinds working against it. That being said, I have no idea when it will happen. It could be next month. It could be next year.

        As John Maynard Keynes eloquently put it, the market can stay irrational longer than you can stay solvent! (One more reason I never short stocks)

        1. Condodweller says:

          @Chris That is a very good saying. One of my favourites is patience is a virtue. Once someone came to the conclusion in 2007 that buying a house didn’t make sense to them because they thought prices were high, why would it make sense for them to buy in a later year when prices continued to go higher? The only reasons I can think of is if they had a windfall of some sort and it actually became more affordable for them or if their rent has increased so much over the years that buying at a higher price makes more sense. The latter is dubious but there may be certain situations where it might make sense.

          That 18 years must be an average number as we are in our 28th year of our current cycle which should in itself mean something to all the bulls around here.

          1. Chris says:

            Condodweller,

            Keynes was a pretty smart guy!

            I tend to agree with your assessment. Someone who viewed the market as overvalued in 2007 is not very likely to view it as fairly valued today. I would argue they were probably wrong in 2007, and most data I have seen point to 2007 not being very overvalued (although I have the very significant benefit of hindsight).

            The 18 year figure is indeed an average, taken from research in the United States:

            https://www.extension.harvard.edu/inside-extension/how-use-real-estate-trends-predict-next-housing-bubble

            Taking 1989 as the previous peak, you are correct, we are quite a bit above the 18 year mark for our cycle. But, as the article shows, there are some outliers, with one cycle taking upwards of 40 years.

          2. Condodweller says:

            @Chris That is a great link thanks for posting. I find the following very meaningful WRT RE market cycles:

            “William Newman documented as far back as 1935, the price of land begins to reflect not the existing market conditions but rather the anticipated rent growth to come.
            Investors, believing the price is justified by the future growth, overpay for the land relative to the current market, and start building for a future market. The boom is officially on.”

            Pre-construction condos are a good example of the above. People are now paying higher than future prices.

            “Wise developers, noting the change in direction of rent growth and factoring in the likely consequence of units currently under construction being completed, should choose to stop building. If you find such a developer, please let me know.”

            “New construction stops, but projects started in the hyper-supply phase continue to be delivered. The addition of surplus inventory leads to lower occupancy and lower rents, which significantly reduces revenue for landowners.”

            Clearly we have increasing rents in TO but note how prices have gone parabolic and ask how much longer it can stay like this.

            “The Third Indicator of Trouble
            Finally, investors must watch for the third indicator of trouble: an increase in interest rates.”

            Rates have already started to rise, and they may meaningfully move up despite what everybody believes. Just remember that long term average mortgage rates are above 5%.

            “Vacancy stalks landowners and, as revenues fall below landowners’ fixed costs, foreclosures follow. The real estate cycle comes full circle and, as Foldvary (2007) notes, “shrewd investors pick up real estate bargains.””

            All the “bears” who have held out need to pay attention to this and be ready to jump when it happens. Mind you jump may be too strong a word as in 89 it took about 7 years for things to bottom out. Having said that, anyone who bought their residence, or was lucky enough to have bought investment properties, between 90 and 96 has done well.

          3. Chris says:

            Ya it’s a pretty interesting article! Glad you enjoyed it. I do agree that I draw quite a few parallels between what they discuss and what we are seeing in Toronto today.

            As for jumping in, it depends on what your goals are. If you’re just looking for a place to live, I don’t usually advise trying to time the market; it’s pretty hard to get it right. If you’re a RE investor though, well that’s a bit of a different can of worms now isn’t it. Cap rates on rental properties today are so low that ya, I’m not sure it’s a great time to jump in. Waiting is probably advisable.

  12. Joel says:

    I am broker and agree that from my experience this isn’t going to have a big impact on buyers. I would suggest that maybe 5% of the mortgages that I did last year were purchases where the buyer would not be able to meet the ew stress test.

    What I think is going to cause concern is the inability for many to refinance. Over 50% of the refinances that I have done this year would not qualify for the amount needed. When the people that need the equity in their house to bail themselves out of consumer debt are no longer able to do so, we will see a big change. These clients are going to have to move to alternative lenders at higher rates and if they don’t change their spending habits (which they almost never do) they will be forced to go to private mortgages or sell their houses.

    I think this is going to harm the 40-60 year old group that has grown to rely on their houses. When these people are forced to sell in 3-5 years we will see a much bigger impact than those who are not able to qualify now.

    The government absolutely needs to limit the amount of credit that is given to people, but it is the credit cards and lines of credit that cause huge problems. Too many people spend now on credit with no means to repay. If the rules were imposed to reduce credit extended to Canadians and not just about their homes this would be a much better approach.

    I think that they are tackling the wrong end of the problem. So many less voters care about housing affordability for those in Toronto and Vancouver (because the stress test won’t affect most people in other areas buying a $250,000 home) than their access to credit cars and ridiculous car loans.

    1. Kramer says:

      GREAT POINT!!!!!!!!!!

      1. There is so much other debt out there that is truly BAD debt, and that is what should be attacked… debt without precious assets behind it… why are there not such stringent qualifications for credit cards and LOCs which are the things that really get people in trouble.

      2. Furthermore, B-20 completely overkills… you’re hitting people with 20% down, and you are not taking into account that A) they will be making more money in 5 years, and B) in 5 years their mortgage will be smaller. Overkill.

      When you consider these two points, how can you say this is all about cleaning up bad debt and not about cooling the housing market? If they were worried about debt, they would have attacked L.O.C. and Credit Card lending practices. As of January 1st, everyone is still welcome to take out consumer credit for $50K of marked-up furniture to park in their now smaller living room, or a $75K Lexus to park in their now smaller driveway (or likely now street parking).

    2. Kyle says:

      Agreed with both of you this is a great point. Mortgage debt doesn’t ruin lives, consumer debt does. Compounded when people consolidate their high interest consumer debts (which they can walk away from), into a second mortgage on their home (which they can’t walk away from).

      It is these people who need to be saved from themselves, not the responsible family that has socked away 20+%.

    3. Kyle says:

      @Joel

      Just clarifying, Do you know for sure that the refi you’ve been doing has been used to support consumer habits? My assumption was that much of the refi activity lately has been Mom and Dad, helping Jr. get on the property ladder?

      1. Kyle says:

        @ David Fleming

        I would ask Joe the same question….

      2. Joel says:

        Yes, when refinancing you can see what the debt was from and in having a conversation with clients it is easy to tell where the money has gone. It’s definitely not all clients that are refinancing, but certainly more than 25% are paying out consumer debt.

  13. Condodweller says:

    I encourage those who think interest rates are not going to go up by 2% anytime soon to look at the Taylor rule here: http://www.investopedia.com/terms/j/john-b-taylor.asp.

    I heard somewhere that according to the Taylor rule current rates should be significantly higher than current rates. If you say it’s not going to happen, consider that Trump recently met with John Talyor and reportedly he was so impressed with him that Trump is considering making him the new Fed chairman. Food for thought.

    1. Joel says:

      I don’t think Trump looking at Taylor to chair the Fed gives him any more credibility. Take a look at all of he people that he has placed and then fired, or that have been terrible.

  14. Condodweller says:

    I have a question, David. Those clients of yours who wanted to spend 1.1M but were approved for 1.5M what did they end up spending? Did they stand firm and spend 1.1M or when presented with a multiple offer situation where people were bidding what 300K over, in the end, did they buy for 1.4M? If it’s the latter, I would say it should definitely have a negative effect on prices. All those people who spent 1.4M before will compete for the 1.1M house and those who were approved for .7M and bought for 1.1m will not compete for the .7m house. This will push everyone down the food chain. It will be mitigated by those who will find alternative financing to come up with the difference but the trend should be down.

    Regarding why OSFI did this is neither of the reasons listed above. They want to protect CMHC from mass defaults. Rightly or wrongly is a separate discussion.

    1. Kyle says:

      Has nothing to do with CMHC. B20 applies to uninsured mortgages only.

  15. Chris says:

    Time will tell what sort of impact this regulation will have, but I expect it will be fairly negative on prices. Purchasing power has just been cut across the board. Combined with increasing interest rates, and sales volumes that continue to disappoint, I don’t see a whole lot to be optimistic about in the short term.

    David, to your point that “nobody spends what they are approved for”, anecdotally I have seen people who do exactly that. I have also seen people who turned to other sources of funding (family, private lenders, etc.) in order to get around the previous stress test, which they wouldn’t have passed with their income levels. Recent statistics on debt to income ratios, and the growth of uninsured mortgages seems to indicate that these anecdotes are fairly widespread. Hence OSFI’s new regulations to prevent exploitation of these loopholes.

    1. Daniel says:

      Or maybe time won’t tell. If this qualification rule doesn’t knock the market down will you then agree that the underlying fundamentals of toronto borrowers are sound? More pointedly, isn’t the whole point with the housing bears is that time won’t tell. Unless prices return to inline with 30% of people’s salaries and a 2% LT growth curve then we’re definitely in a bubble – all other evidence to the contrary…

      I tend to agree with David that, anecdotally, very few people max out their qualification on their mortgage borrowing. Your statement that “purchasing power has been cut across the board” only holds true if people are largely taking out mortgages that wouldn’t pass the stress test.

      1. Chris says:

        Sorry, I don’t really understand your point. This rule does not directly change the underlying fundamentals of the Toronto market, upon which I base my assessment. Price to income, price to rent, population growth, construction starts/completions, etc. This rule impacts availability of credit. This may then have an impact on price, or it may not, but it does not directly change the fundamentals.

        I’m also not sure where you’re getting your figure of 30% of peoples’ income? Perhaps you meant 3.0x income? That is a more traditional metric.

        Finally, my statement that purchasing power has been cut absolutely holds true. Purchasing power means the availability of credit (used to purchase a home in this context).

        So, if I am looking for a mortgage, and prior to this rule, my income would have allowed me to borrow $750,000, and now it is $650,000, my purchasing power has been cut. Even if I bought a home for $250,000, I still have less credit available to me than I did before the implementation of these rules.

  16. JB says:

    I think it’s a bit of a stretch to say that none of the changes since 2008 have cooled the market. Sure, the market has been consistently hot since then, but don’t you think it would have been even HOTTER if there were still 107% mortgages and 40-year amortizations? Government rule changes can’t break the laws of supply and demand, but it can certainty affect some marginal buyers.

  17. Kramer says:

    “I know, I know – the bears are digging their claws deep into the linoleum tile of their rental apartment right now, predicting Armageddon.“

    Hahahahahahahahahaha. Great line.

    1. Chris says:

      Yeesh. Come on. What is it with this attitude?

      As I said to Kyle the other week, this is entirely a question of valuation. It’s not a team, it’s not a side, it’s not a cult. I would be labelled a bear because I view Toronto real estate as currently overvalued. But I doubt I will be a bear forever. There will certainly come a day that, in my mind, Toronto real estate is fairly or under valued.

      This disparaging attitude towards anyone who thinks real estate is overvalued is really quite odd. If you owned Apple stock and someone told you they felt the stock was overvalued, would you slam them as being a “priced out non-shareholder just jealous you didn’t get in soon enough!!”

      I suppose it’s not surprising given how emotional people get about real estate, but still…Attack the argument, not the person making it.

      1. Kramer says:

        I thought it was funny just because of how over the top it was. Well done David.

        Come on Chris, you laughed.

        1. Chris says:

          I will admit I laughed at this line:

          “but I knew one or two readers would say, “I expected more from you, David,” and I didn’t want to be reminded of the first time I was ever with a girl.”

          because that probably would have been me!

          However, I do feel the need sometimes to remind everyone that we’re not on opposing teams (bears vs bulls). When you get right down to it, we’re discussing valuation of an asset class. And while David was probably joking, many times my own, and other bearish attitudes are talked down or dismissed as being “you’re just an angry priced out renter!!” (even though I don’t live/work/rent/own in Toronto, nor do I have any plans to…and before anyone asks why I’m commenting on a blog about Toronto real estate, I live in the province, have friends/family in Toronto, visit for business/pleasure, and recognize that the real estate market there is so massive that it impacts the entire province).

          Now, obviously you don’t do this, Kramer, but a number of people do. Hence, my initial post.

          1. Kyle says:

            Like i said before, maybe it doesn’t apply to you, but it certainly applies to many other out there. We’re not talking about valuations, we’re talking about behaviours. Having argued with many bears over the years, it is obvious that there are many out there suffering mild to severe forms of cognitive dissonance, and it ranges from bias-confirming behaviour all the way to willful blindness to outright delusion.

            Serious exercise to all those with a bearish outlook given we now have lots of practical examples. Look at the list that David provided ( i added two more at the end just for fun):

            *Eliminating 107% financing and other products that require no down payment, and offer money back on closing
            *Instituting a minimum 5% down payment rule (from 0%, or negative down payment, as above)
            *Eliminating the 40-year amortization
            *Eliminating the 35-year amortization
            *Instituting a minimum 20% down payment rule for second properties, ie. investment, or non-primary residence
            *Increasing the downpayment for purchases over $1,000,000 to 20%
            *Ensuring all borrowers qualify at the 5-year, fixed-rate mortgage on a 25-year amortization (this was a precursor to stress-testing)
            *Increasing CMHC insurance premiums
            *Increasing the downpayment for the portion of purchase price from $500,000 – $999,999 from 5% to 7.5%
            *Creating a “stress test” for insured mortgages, ie. those under $1,000,000.
            *Drop in oil and other resource prices
            *Home Capital Group financial troubles

            Now BE HONEST WITH YOURSELF, if at the outset of each of these events, a little flicker of hope ignited in your heart and you said to yourself (or outloud) that this would be it, this will be the turning point and the market is going down from here. Only to turn out being wrong, and then repeat and repeat again and again with each subsequent event on the list.

            If that’s something one has done for any more than three of those events, then that says something about how entrenched and unopen ones’ mind is. And that person should ask themselves what it is they are refusing to accept and why it is difficult for them to accept it.

            Albert Einstein once said, “the definition of insanity is doing something over and over again and expecting a different result.”

            Now on the other hand, if someone said,”Gee i was wrong that time and the time after…Why was i so certain, and how was i so wrong?
            Maybe my assumptions weren’t right or maybe my conclusions have been skewed by what i wanted to see happen” Then i would say that person is rationale and not a “bear”

    2. John says:

      A lot of bears I know were in the position to buy a 400k house back in 2007, but decided to rent instead (and have done so for over 10 years). I can understand if they are bitter. I would be too.

      1. Tommy says:

        Yes and finances aside, we only get one life to enjoy. Let’s say prices were to magically return to $400k next year. That’s over 10 years of waiting on a lifestyle they could have enjoyed all that time even if they were prudent savers or stock investors for that time. The people that bought 10 years ago are already 10 years into paying off their mortgage, with the life experiences of home ownership for a decade. How many decades can one sacrifice in a lifetime for the “right time” to get in? It doesn’t take long to become old.

  18. Real estate millennial says:

    I understand that you don’t want to come across as that sales guy championing the market constantly which is fair. To me it sounds like the boy who cried wolf, there have been so many false narratives that we don’t know what a real one looks like. What’s the difference between raising interest rates and testing at a higher rate? This just sounds like the artificial raising of interest rates. (Maybe I’m stupid but if a $600,000 mortgage cost $2765/monthly @2.75% but $3486/monthly @ 4.99%). I can’t speak on everyones personal finances but it seems like the same mortgage just got a lot more expensive. I don’t think the correlation will be equally reflected in prices but to imply there will be no affect like the last decade of policy changes seems a little irresponsible. It should make for an interesting spring market.

    1. Kyle says:

      @REM

      “it seems like the same mortgage just got a lot more expensive”

      Not the case. Under the new rules, your payments aren’t based on the higher rate. The higher rate is only used for mortgage qualification purposes.

      1. Chris says:

        Exactly. And raising interest rates impacts the entire economy. It is a very blunt tool. This stres stess impacts mortgages and real estate exclusively.

  19. Ralph Cramdown says:

    “… the government has spent the better part of the last decade changing policy in attempts to cool the housing market …”

    It should be noted that the last decade has encompassed 2 1/2 finance ministers, 2 central bankers, and 2 federal governments from different parties. The current Superintendent of the OSFI was appointed by PM Harper to a 7 year term. Sure, PM Trudeau could reappoint him or replace him at end of term, but there’s practically no way he can be fired.

    1. Appraiser says:

      Is it Flaherty who counts as half ?

      1. Jennifer says:

        lol

  20. Appraiser says:

    It is arguable whether or not we are experiencing regulation over-reach here.

    Is it overly prudent? Perhaps.

    Is it super-Canadian? Yeah.

    Another nail in the coffin for those with linoleum under their finger nails, still praying for a U.S style property melt down.

    1. Kyle says:

      IMO, it is definitely an over-reach and a massive kick in the groin to good savers. There have always been home buyers who have worked hard and responsibly saved to buy their first homes, but now Jeremy Rudin has decided that despite the fact that these people had the wherewithal and prudence to save up 20+%, that they are no longer qualified to buy as much house as they can actually afford.

      1. Appraiser says:

        It’s also a kick in the groin to the rest of the nation, where real estate has not been red-hot. Unfortunately it’s not just Vancouver and Toronto that are affected.

        Beware unintended consequences.

        1. Kyle says:

          True, add to the list self-employed people and small business owners. Who already have a harder time qualifying or who end up paying more taxes, because they are forced to pay themselves a higher salary to make their income larger.

        2. Chris says:

          Can you point me to some of these markets, outside of Toronto and Vancouver (and their ancillary markets, e.g. Victoria, Guelph) where real estate is red-hot?

          Because here’s the 5 year appreciation of some other big Canadian markets (from CREA):

          Calgary – 13.2%
          Regina – 3.6%
          Saskatoon – 7.7%
          Ottawa – 10.7%
          Montreal – 12.0%
          Moncton – 13.6%

          A far cry from the red hot markets of Toronto (63.6%) and Vancouver (70.1%).

          1. Daniel says:

            You’re 100% percent misreading his comment. He is saying that the other parts of canada are not red hot, and thus will be impacted by the stress test even though they’re not in bubble territory.

            That said, i actually don’t have a problem with this. A major difference between Toronto and say, Sarnia, is that when someone in toronto making $250k spends half their income on housing they still have a fair bit of cash left over vs someone in Sarnia making $60k a year and spending half their income on housing.

          2. Chris says:

            Ah, you are correct, my mistake. Thanks for pointing that out.

            Then his read on the proposed changes is incorrect. As you pointed out, in less red-hot markets, where median price to median income is not so skewed towards unaffordability as it is in Toronto, these new regulations are a non-issue.

      2. Tommy says:

        Theoretically those prudent savers should be unaffected by this because they’re the kind of people that don’t max out their credit and in fact plan for interest hikes in the future. This new policy will largely effect those who do not plan and do not make enough to ensure they’re insulated from interest hike shocks in the future. Given debt levels, there may be many people like that in the market, and this policy will ‘save’ them from themselves in the long run.

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