We’ve seen residential home sales plummet in Vancouver. What will happen in Toronto?
As most of you are aware, Vancouver recently imposed a 15% tax on foreign buyers which has effectively stopped foreign investment there dead in its tracks. The sudden escalation in Toronto home prices is seen by some as a signal that foreigners are diverting their capital to the Toronto market which is already on fire. If this is true, there will be pressure on Toronto to act expeditiously and perhaps follow Vancouver’s lead with a tax of its own. Double-digit home price growth is surely suggestive of speculation. I am reminded by the priceless words of legendary investor Sir John Templeton:
Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.
Which phase of the cycle do you think we are in now?
Major changes in the housing and mortgage markets were announced over the last weeks amid concerns that the market might be “rolling over” and bringing with it serious risks for the financial system. Under Canadian law, home buyers who put down less than 20% of the cost of a home must purchase mortgage insurance.
In its last quarterly financial report, CMHC (Canadian Mortgage and Housing Corporation) reported $523 billion of insurance-in-force of which portfolio insurance amounted to $189 billion. Portfolio insurance allows lenders to insure mortgages that aren’t already backstopped by the housing agency and makes up about 35% of the mortgage insurance market in Canada. CMHC’s totals as well as 90% of the loans insured by 2 private insurers are guaranteed by the Federal Government, meaning us, so we’re all exposed to a market meltdown if one should occur. (If this concerns you as much as me, consider hedging the Canadian currency or look at the option to short positions that are most exposed).
Summary of the New Mortgage Lending Rules:
Recognizing its exposure, the Federal Government is moving to tighten mortgage lending rules and look at ways of risk-sharing with other lenders. Changes to qualifying criteria for mortgage insurance will likely affect first-time home buyers the most. In order to qualify for mortgage insurance after October 17, 2016 the borrower’s ability to pay will now be stress tested at the Bank of Canada’s 5 year fixed rate (an average of the rates posted by the 6 biggest Canadian banks). As of the end of September this rate was 4.64%, a rate higher than most borrowers could negotiate. In addition, the borrower’s expenses on home carrying costs such as mortgage payments, property taxes and utilities cannot exceed 39% of income. Finally total debt service costs (on all debt) cannot exceed 44% of income.
From November 30, 2016 the same rules apply in cases where a borrower makes a down payment of more than 20% but the borrower or lender wish to purchase mortgage insurance. In addition, the mortgage amortization period must be 25 years or less, the home’s value cannot exceed $1 million, the borrower’s credit score must be greater than 600 and the home must be owner-occupied.
These new rules will apply across Canada despite the fact that many markets have shown no signs of excessive price appreciation.
Recent reports in the press have suggested that some foreign buyers have flipped houses and escaped taxes by claiming the principal residence exemption. Going forward the sale of a principal residence will need to be reported for tax purposes. The proceeds will still be exempt from tax if the home meets the criteria for the principal residence exemption. In view of the proposed reporting requirement, we suggest you keep diligent records (including receipts) of all renovations, additions and capital expenditures which will increase your initial purchase cost. Do the same for any recreational property you own in Canada.
As a further step in mitigating its exposure for insured mortgage defaults, the Government of Canada is commencing risk-sharing consultations with banks, lenders and other stakeholders. Their aim is to transition to a more balanced system. A process like this will inevitably lead to an increase in costs which will be passed along to borrowers in the form of higher interest rates.
It leaves me wondering how many mortgages might not have been written if a balanced system was already operating? Would home prices still be as high?
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