The Bank of Canada Remains Cautious … For at Least As Long as Rising Wage Pressures Will AllowDecember 11, 2017
Canadian Mortgage Rate Forecast for 2018 – Part 1 (Five-Year Fixed Rates)January 8, 2018
This year, in addition to thinking up soon-to-be-broken new year’s resolutions, many Canadians will be wondering, and worrying, about the impact that the next round of mortgage rule changes will have on our mortgage and housing markets as well as on our overall economic momentum.
Their concern is warranted.
The Office of the Superintendent of Financial Institutions (OSFI) is about to implement the most substantial mortgage rule changes to date. As of January 1, among other changes, conventional borrowers (who make down payments of 20% or more of the purchase price), will be required to qualify using a stress-test rate that is significantly higher than the actual rate they will be paying on their mortgage.
To put that in perspective, conventional borrowers make up about two-thirds of the total Canadian mortgage market. (You can read my detailed explanation of the coming rule changes here.)
In today’s post, in the spirit of another new year’s tradition, I’m going to poke my neck out further than usual and offer predictions on how I think the impacts from the coming mortgage rule changes will materialize in the new year. (Note: The only certainty with the following predictions is that when you combine them with $1.50 you can buy one cup of hot coffee.)
The next round of mortgage rule changes will produce a combination of technical and psychological impacts on our real-estate markets
The technical impact is relatively easy to quantify. Most Canadians choose to borrow well within their affordable range and as such, it is estimated that the new stress test will affect only about 15% of conventional borrowers.
Those borrowers who are affected will have to choose between reducing their maximum purchase price or delaying their buying plans. If two-thirds of them choose the latter option, our regional housing markets will lose about 10% of their conventional buyers overnight.
That may not sound like much, but markets are made at the margin and over the short term, this will cause a material drop in demand. Over the long term, these lost borrowers should gradually filter back into their local housing markets as their incomes rise or their purchasing plans are scaled back. For those reasons, I expect the technical impact of the next round of mortgage rule changes to dissipate over time.
The psychological impact of the coming rule changes is more difficult to forecast. Potential home buyers who aren’t directly affected may decide to postpone their purchase plans out of fear that the changes will cause house prices to fall sharply.
We saw recent examples of this when the governments of British Columbia and Ontario implemented foreign home buyers taxes (in 2016 and 2017 respectively). While the technical impact of the new tax on these provincial markets was minimal, because relatively few buyers were directly affected, the psychological impact on buyers was much more significant. In both provinces, buying activity and price appreciation slowed materially over the short term (although in both cases, they eventually rebounded).
The coming mortgage rule changes, which will apply to all federally regulated lenders, will have a greater technical impact than the British Columbia and Ontario foreign home buyers taxes, and as such, I expect the psychological impact on our regional housing markets to be greater as well.
This will be especially true for the Greater Toronto Area (GTA), where the psychological impact is likely to be magnified by other developing trends. To wit, house prices and sales activity peaked in the GTA in the spring of 2017. Since these measures are most prominently compared on a year-over-year basis, if average GTA house prices and activity stay the same between now and the spring of 2018, they will still be down by as much as 20% when year-over-year comparisons are made at that time.
Given the mainstream media’s penchant for sky-is-falling real-estate headlines, that 20% year-over-year drop in prices and sales activity may be mistakenly attributed to the sixth round of mortgage rule changes (when they had, in fact, already been baked into the data). If that happens, the short-term psychological impact of the mortgage rule changes on GTA real-estate markets will be exacerbated even further.
While negative housing-market momentum can be self-reinforcing, I expect that both the technical and psychological impacts of the next round of mortgage rule changes will prove temporary. Over the longer term, I am more optimistic that the underlying factors that have underpinned the strength in our regional housing markets will win out. (These factors include supply/demand imbalances, record levels of immigration and the continuation of the current low-interest rate environment.)
Here are five other predictions relating to the coming mortgage rule changes:
- Big Five bank earnings will take a hit in 2018 – Mortgages account for about one-third of the Big Five’s total retail profits and despite reassuring statements from their senior executives, these changes, which were aimed straight at them, will bite.
- Credit union mortgage market share will grow – Credit unions represent the largest non-federally regulated lenders in Canada and while they may voluntarily adopt the OSFI changes, they will have more flexibility to cherry pick from the best mortgage applications that fall through the cracks under the new rules.
- Monoline lenders will see a rebound in mortgage originations – The sixth round of mortgage rule changes redresses some of the unfair advantages given to the banks by earlier changes. They will help to level the playing field and will allow larger monoline lenders, like First National and MCAP, to compete more effectively with the banks.
- Mortgage brokers will see their market share grow – For all of the collective hand wringing by my industry compatriots leading up to this next round of rule changes, the mortgage market is now more complex and difficult for borrowers to navigate than even before. Truly professional brokers who really know their stuff will be needed more than ever.
- The predicted rush to buy before the January 1 deadline won’t materialize – The data will show that borrowers did not run out to buy houses prior to the January 1 rule changes. Buying a house just isn’t like buying a new pair of jeans and any uptick in the sales data will be minimal.
Lastly, no post of mine is complete without a discussion of interest rates, so I’ll close by predicting that the mortgage rule changes will be one of the main factors that keeps the Bank of Canada (BoC) on hold for longer than the consensus now believes. This will be due to several factors:
- The BoC will want time to observe how the most sweeping mortgage rule changes to date will affect regional housing markets.
- The coming mortgage rule changes are designed to slow our rate of borrowing, and less borrowing means less spending. Simply put, debt-fuelled consumer spending has been the main driver of our economic growth over the past several years. If consumer spending slows, our policy makers hope that business investment will pick up the slack, but it’s hard for me to envision businesses becoming more confident at the same time that consumers (their customers) become less so. (I wrote about this in detail here.)
- Consumer spending accounts for more than half of our overall GDP, and as such, less spending will also mean less GDP growth. If GDP growth slows, so too should our employment and income growth, which are the main drivers of overall inflation. As inflationary pressures ease, the BoC will have to move from offence back to defence (to quote BoC Governor Poloz’s terminology in a recent Globe & Mail interview).
The Bottom Line: The coming mortgage rule changes do have the potential to materially impact our hottest regional housing markets over the near term. That said, I believe that both the negative technical and psychological impacts associated with these changes will dissipate over the medium term and that our regional housing markets will ultimately prove resilient.