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More radical course change required

January 15th, 2016 · No Comments

The newly minted Minister of Finance, Bill Morneau, wasted no time in announcing rules further restricting the Canadian Mortgage and Housing Corporation’s (CMHC) ability to “backstop” loans to homebuyers. Effective Feb. 15, 2016, purchasers of homes whose purchase price exceeds $500,000 will be required to put at least 10 per cent down, which is up 5 per cent from what it was under the previous Conservative government. This is the federal government’s latest attempt to dampen a housing market that is widely seen as vulnerable to a radical readjustment, especially in the event of an increase in interest rates.

The initiative pays lip service to the problem of a grossly inflated real estate market that some believe the previous government had a big hand in creating. The new 10 per cent down payment requirement is misleading as it applies only to that portion of the purchase price over $500,000. For example, when purchasing a $700,000 property, the buyer must put down 5 per cent on the first $500,000 of the price and 10 per cent on the remainder — effectively only 6.4 per cent overall.

The CMHC is a federal government vehicle that allows homebuyers to enter the residential real estate market by guaranteeing that the banks will be paid in the event that a loan defaults. Initiated in the 1940s, it accommodated a post-war housing boom, and many of the homes built with CMHC-backed mortgages still stand today.

It can be observed now, however, that CMHC policies, taken together with historically low interest rates, have not only failed to regulate the real estate market effectively, but served to overstimulate home prices, making home ownership in Toronto inaccessible to most, a situation entirely contrary to the agency’s raison d’être.

In 2006, the then newly-elected government of Stephen Harper introduced, through the CMHC, the now infamous mortgage instrument consisting of zero down and 40-year amortization. This created a market imbalance wherein the buyer pool was radically expanded. It also had a more pernicious impact that will be harder to counter: it created a culture of debt. Indeed, CMHC policies removed the fear of debt and created a market where neither buyers nor banks (because the government guarantees the debt) have much skin in the game. This policy was unfair and remains so to those who have real cash in hand, so a buyer with a 20 per cent or more down payment pays the same mortgage rate as a buyer with a 5 per cent down payment. Perhaps paradoxically, the person with the larger down payment will require an on-site physical appraisal of the property, whereas one with a CMHC-insured mortgage typically does not.

In last month’s Focus on Homes section the average price for a house in the Annex was a little over $2 million. Out of 13 properties, only two were priced at less than $1 million. If you own one of these insanely priced Toronto homes, you have access to an incredible amount of cash in the form of home equity loans. According to the Accredited Association of Mortgage Professionals, 2.15 million people have home equity lines of credit. Borrowing against home equity can be done at a much lower rate than using a credit card, but it basically converts your principal residence into an ATM. One’s ability to service this debt, and the underlying mortgage, would be severely hampered by an increase in interest rates and so the problem of increased and disproportionate valuation is made manifestly worse with home equity loans.

Morneau’s intervention follows others that the previous government instituted in recent years. According to the Toronto Real Estate Board, house sales in the 416 area increased by 8.8 per cent in 2015, while inflation was at 1 per cent over the same period. The real estate market is becoming increasingly surreal while the economy struggles.

Morneau describes his approach as nuanced, but we would call it paltry, and perhaps an admission that there is no gentle way to get this under control. The ship is headed for the rocks, and a more radical course change is required.

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