Over the last decade house prices in Canada have doubled and the market continues to grow. The demand for property is illustrated by the fact that there are 173 sky scrapers being built in Toronto, the highest number in North America. New York, with nearly four times the population, has only 96 under construction, while Chicago has just 17.
The continued growth is due to the strength of the Canadian economy and The Bank of Canada keeping interest rates at record lows, with our five year fixed rate currently at 2.99%. The low fixed rate, combined with mortgage insurance underwritten by the Canadian Mortgage and Housing Corporation (CMHC), has led to financial institutions lending out record amounts to both Canadians and foreign speculators who have hoovered up property in Canada. Additionally, the competition for property is so intense it has pushed house prices up to the highest levels ever, meaning the average Canadian needs to take on even bigger loans to afford the ever increasing price of housing in Canada.
The Canadian government has been concerned for some time that Canadians are over extending themselves by taking on larger loans or are simply being priced out of the housing market. Mark Carney, the governor of the central bank, has warned for years that Canadians are consuming beyond their means. In fact, a recent report from Bank of America proclaimed Canada is “showing many of the signs of a classic bubble”.
To combat the problem, the Canadian government announced several measures aimed at cooling the growth. Last year they made several announcements which can be summarized in this article. Now we are faced with another issue, the government is widely expected to not approve an increase to CMHC’s $600 billion mortgage insurance limit.
CMHC, which is a crown corporation, owned by the government of Canada, is the largest underwriter of mortgage insurance for financial institutions and serves to protect against defaults and stimulate the housing market. In Canada, all high ratio mortgages, or those with less than 20% in equity, have to be insured – a cost which is paid for by the borrower. However, lenders have also been insuring and paying the premiums for default insurance on mortgages with over 20% equity or low ratio, conventional mortgages. These low ratio mortgages account for nearly 75% of mortgages that are insured in bulk by CMHC. The organization was not designed to take on this level of low ratio mortgage insurance and thus we are in this predicament.
So should CMHC’s limit be increased? We believe it should. CMHC was designed to help Canadians realize homeownership while protecting lenders against high ratio mortgage defaults. The theory was that by doing this they would stimulate the housing market and help motivate competition by providing bulk insurance for small lenders who need it. However, CMHC’s goals have been distorted by major banks that have insured mass amounts of conventional mortgages at lower negotiated costs to limit competition and in turn increase their profits.
Who will be affected if the limit is not increased? Smaller lenders, who have less capital than banks, rely on CMHC in order to resell their mortgages to investors and free up capital to lend once again. In the past these smaller lenders have had lower working costs than banks, so they could offer lower rates. With restricted access to CMHC and recent changes to accounting rules, these lenders must have more capital in reserve, which means they will not be able to aggressively offer lower rates than the banks in conventional mortgages. Thus the banks have seemingly cut the competition out of the market place since they have the ability to keep mortgages on their books for longer given their ability to generate the capital required in their reserves.
Other changes as a result of the CMHC limit being reached could be
- Bank capital costs will increase leading to mortgage rates being increased, however the bank still wins as they will have less competition in the conventional low ratio mortgage market as small lenders don’t have the capital to compete.
- Given their reduced access to portfolio insurance and thus the reduced potential for low-ratio mortgage business, smaller lenders may now get even choosier on which conventional borrowers they lend to limiting conventional mortgage options somewhat, unless you are a top-qualified borrower.
- Less liquidity in the market place. This will impact products that have higher insurance costs, such as stated income & self-employed. They will either be stopped or the rates charged to these clients will be significantly increased.
- It will discourage new non-bank lenders from entering the market and therefore give less choice for mortgage shoppers.
- It will force lenders to find alternative, uninsured funding sources for conventional mortgages. We believe that this is a double negative for taxpayers. Firstly, there is less risk for CMHC in insuring low Loan to Value (LTV) mortgages regardless of the income of the borrowers and this portion of their business will be finished. Secondly it will lead to increased mortgage rates for all consumers.
- Brokers may be increasingly forced to rely on banks for conventional financing.
- Private insurers will grow such as Genworth and Canada Guaranty, as CMHC refuses financial institutions bulk insurance. These private insurers will be able to charge more for bulk insurance in turn pushing up mortgage rates.
In conclusion if the CMHC limit isn’t raised the winners will be the banks. The banks have realised if they use up all of the CMHCs low ratio mortgage insurance allocation and the limit is reached it will hurt the competition and less competition will enable them to dictate mortgage rates. Furthermore with less competition and less options for mortgage shoppers the banks will pressure existing customers into renewing with them even though with a good mortgage broker a borrower can often find much better deal.
However it’s not all doom and gloom, the good news is firstly that this does not as yet affect high ratio mortgages and secondly the Canadian government has seen the collapse of the real estate market in the US and across the globe and appear to be taking steps to assure a gentle stabilization of the market. One thing that can cause trouble is people securing mortgages above a comfortable amount for their budget. With a good mortgage broker, the consumer can find quality homes within their monetary comfort zone, thus adding stability to the market.
It is highly unlikely there will be a house crash in Canada similar to the United States crash in the 2000s where 30% was knocked off home value.If you or someone you know is looking for a mortgage and you think they would benefit from sound, unbiased mortgage advice please contact us.