‘Twas the night before Christmas, when all through the house – not a creature was stirring, not even a mouse. Well, except for Evan Siddall… fine, it was the afternoon and he was on Twitter. On Christmas Eve, the CEO of the Canada Mortgage and Housing Corporation (CMHC) defended mortgage stress testing. The head of the agency warned first-time buyers that a stress test is unfair, but it’s better than risking your home.
The Who? From Where?
Evan Siddall is everyone’s favorite renter/former Goldman Sachs exec, that happens to be the CEO of the CMHC. For our new readers, the CMHC is the Crown Corporation that acts as Canada’s national housing agency. They play an important role in providing mortgage liquidity.
Who he is pretty important for context here. He’s not a short-seller your real estate agent convinced you might have another angle. He’s not someone that’s jealous of your 300 sqft condo with a combination bathroom/kitchen. This is the person who the government appointed to help you get a mortgage to buy a home, and help banks manage risk.
Stress Testing Real Estate Buyers
Unfamiliar with stress testing? Stress testing is when lenders make sure a borrower can pay their mortgage at higher rate. The majority of new mortgages in Canada require a stress test. This helps to ensure borrowers can continue to make payments if borrowing rates rise. Borrowers that pass a stress test, also show they have a little wiggle room for emergencies. An unspoken benefit is owners can top up equity in the event the home falls below a critical threshold. Negative equity for instance, would require a top up, and you’ll need extra cash to pay that Realtor.
Ensuring a borrower can continue to keep their home, even if their expenses rise? Those Canadians are monsters! At least that’s what some politicians and real estate developers have been saying. Afterall, before 2016 there was no test, and the market did, uh… just fine. Many believe that the rules should be put on hold, until the impact can be studied. It’s unclear if these people understand the irony of what they’re promoting. They want the impact to industry to be studied, before lenders are required to study the quality of their borrowers. Clearly the generosity of our selfless politicians and real estate developers knows no bounds.
Sucks To Be Stress Tested, But It’s Better Than Losing Your Home
In just under 400 characters, Siddall gave an important lesson on risk to buyers that might think it’s unfair.
1/2 Seems unfair that the stress test makes home ownership harder for first time home buyers; but would be worse to risk loss of their home … https://t.co/seuAejnS3e
— Evan Siddall (@ewsiddall) December 24, 2018
2/2 After five years, FTHBs might gain 18% on equity with +10% home value but LOSE 200% with -10% price decline (95% LTV insured mortgage); max leverage can be as high as 82:1 with negative equity after realtor commissions
— Evan Siddall (@ewsiddall) December 24, 2018
Important advice, but probably not actually decipherable by a first-time home buyer (FTHB). Let’s do some napkin math, and run the scenarios laid out. Today’s calculations are on a $500,000 home at 5% down (the 95% LTV), with a 5 year fixed mortgage at 3.89% and 25 year amortization. That means the buyer put $25,000 down, and added $19,000 to the mortgage for insurance. At the end of 5 years, the buyer will have paid $64,782 towards principal, and $89,369 towards interest. We’re only going to be using the $154,150 in payments over 5 years. Costs like taxes, maintenance, and insurance will be excluded.
First scenario is prices go up 10% over those 5 years. In the event that does, you’ve made a $50,000 gain, bringing the value of your condo to $550,000. Combine the gain with the amounts you’ve contributed to principal, and you have $139,782 in equity. The power of leverage, amirite?
The second scenario is prices go down 10% over those 5 years. In the event this happens, the value of your home drops $50,000, bringing it’s value to $450,000. That’s the 200% loss of the down payment he’s referencing. Combine your down payment, amount contributed to principal, and you have $39,782 left. Life’s hard when you pay $179,150, to be left with less than $40,000. Turns out leverage works both ways.
Isn’t That Always True?
Yes, this could happen at any point. 5 years ago, you could have put money down in Toronto or Vancouver, and added a nice chunk of equity to your name. Or you could have put it into a home in Calgary and lost 7.73% plus carrying costs. There’s always a risk, but you try to balance that with probability.
Canadian Real Estate Prices
The 12 month percent change for the price of a “typical” home across Canada.
Source: CREA, Better Dwelling.
Towards the end of the real estate cycle, gains tend to taper or turn negative. This is especially true after a large run in real estate prices, after gains may be exhausted. Siddall isn’t making a statement on whether we’re at the peak yet. However, he does appear to be saying you’ll be glad there was a stress test if we are.
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Finally, the math no one ever talks about, interest rates. When I bought, the interest on the mortgage almost made my eyes water.
After 5 years, your $179,150 investment leaves you with $139,782. You paid $39,368 to make the $50,000 if it goes up 10%. Net return = $10,632. That’s a 5.93% return over 5 years, or 1.16% CAGR.
A GIC @ 3% with $25k down and your principal contributed annually would net $9,602, with zero percent risk. If you’re a renter paying less than $1,489 (the cost of interest on the loan, and more than the median renter is paying in Toronto), you’re probably better off staying put. There’s also property taxes, condo maintenance to consider, which could make your non-recoverable expenses in your first year more than $2k.
Yes, the cost of interest is going to go down theoretically, if the cost of financing doesn’t rise. But there’s a real risk the cost of financing could rise, or property values can go down after a 50% over 3 year run.
Now imagine you put that in the NASDAQ and net 11% average returns over the past 40 years? You’re looking at closer to a $40,080 return. Of course, just like real estate, you need to balance the returns over the long run. Climbing the property ladder is how banks consistently make sure you do the first 5 years of your home purchase, when you pay the most interest, over and over again.
Real estate is an almost foolproof way to save for retirement though, if you’re too lazy to learn how investments work and don’t have the discipline to allocate yourself. It’s definitely not how you make real money.
I really needs one of those houses that cost nothing to maintain and is exempt from property tax. You have to account all the expenses when comparing to rent, because these are built into the rent.
Right? My house is a money pitt, and do are most people’s I know. That’s why us homeowners are so cranky when people tell us they’re going to rent. “No, I didn’t want to do this, so you’re going to have to now!” It’s like having kids. 😂
Where’d my overseas annual vacations go? Oh, yeah….property tax bill. Why don’t I eat out every week? Oh, yeah…home repairs. Window here, faucet there, squirrel made a hole in the roof, fence came down in the windstorm….money, money and more money.
Peace and quiet is so expensive.
I’m probably 60k into renovations after my first five years. That’s if the value of my time is at zero, I’m probably way past two thousand hours of work and maintenance. At my charge out rate at my firm that would be 76% of the value of my house. Good thing I mostly enjoy the work and love using tools, but if I had kept renting and worked that time for clients I would be way ahead.
That chart actually looks like gains have bottomed, and will return to rising. A good time to buy, since real estate always goes up over the long term.
Ahhh…Professor Trolly McTrollington welcome and thank you. Tock.BD4L.
LOL
Trust me, I’m a real estate agent
Oh no. After creating a bubble and removing any risk from the banks and putting it on the taxpayer, the CMHC doesn’t get to pretend they’re saving the market. You know how much money these guys inflated the real estate market by, forcing the economy into investing into more non-productive assets? It’s absurd.
Banks need to be responsible for their own risk, and the government needs to stop making things “more affordable” by giving banks access to cheap credit.
Couldn’t agree more. The banks are nothing but rent seekers. A little foreign competition might help.
Bank of Canada holds rates, revised growth forecast 20% lower. Over leveraged investors are about to get wrecked with liquidity loss either way.
This is why FTHB’s shouldn’t be afraid of rising interest rates.
With previous buyers maxed out on borrowing credit, reduced liquidity (higher rates) will push prices down by sheer lack of available money.
Higher interest rates and lower home prices can work out to term savings.
Just to throw in some comic relief, I had to post this beauty – reno raised ranch in Burl in a neighbourhood of $6-700k homes (nice reno mind you):
https://www.realtor.ca/real-estate/20140003/3-2-bedroom-single-family-house-568-dynes-road-burlington
That’s impressive. Sold for $850 in March 2017. I really don’t understand what people like about that type of grey industrial reno, but maybe it’s me.
Streetview really helps with the comical aspect.
Good find, CJ. I know Burlington. That house does not belong on that street.
I agree with Someguy below. The living room doesn’t look very inviting. And the kitchen; I’m not a professional chef. I don’t want/need that. That kitchen belongs in one of those artsy one-off bistro type places.
Sadly, I have a feeling it’ll get $1mil+. Torontonians keep getting squeezed and they keep heading towards Burl/Hammer/Ancaster/Dundas/Grimsby.