Canada

Canadians Are Going To See A Huge Reduction of Borrowing Power… On Top of Stress Tests

Canadians Are Going To See A Huge Reduction of Borrowing Power... On Top of Stress Tests

Canadian real estate buyers are going to see a massive reduction in buying power, on top of stress tests. The Office of the Superintendent of Financial Institutions (OSFI) stress test came at a very peculiar time. Canadians are hearing the economy is booming, but are also being subjected to a stress test. The test protects buyers from any potential interest rate shock, but this is an odd decision.

Rising interest rates have built-in protection. They already lower the amount households can borrow as the economy improves. To illustrate how the stress test complicates the housing market, we prepared some projections. If you thought the stress test was bad news for real estate, prepare for an even worse environment with rising interest rates.

Projecting Mortgage Rates Based On Bond Yields, About The Numbers

The Parliamentary Budget Officer (PBO) does a great job projecting interest rates, so today’s model is built on top of their numbers. Coincidentally, when I spoke with Luan Ngo, senior economist from the Financial Accountability Office of Ontario (FAO), he also had similar projections. Both of their projections err on the conservative side of positive. That is, they’re both optimistic on the economy, but they’ve been off by 3 to 6 months. That’s remarkably accurate, considering the number of moving parts in an economy. So today’s mortgage projections are based on these numbers.

There’s also a few other terms you’ll need to know, if mortgage talk doesn’t typically get your motor running. For the mortgages, we’re going to be using 5 year fixed rates, with a 30 year amortization. This means two things, the rate the buyer enters with will be the same for 5 years. This is the most common term according to securitization pool analysis. A 30 year amortization means these borrowers will pay their mortgage off over 30 years. That’s longer than a typical conventional mortgage. The amount these households can borrow will be higher than real world conditions. We’re also going to assume great credit, because who doesn’t have that in Canada?

Note: Some of you have probably seen our interest rate models kicking around your office, and they’re less ambitious. The reason ours are less ambitious, is we feel there’s a complication between a return to “normal” interest rates, and economic output. The PBO is projecting that exports will make up a considerable portion of GDP growth this year. That becomes tricky as interest rates climb, and the dollar becomes stronger. That’s before you try to account for NAFTA potentially falling apart.

Bullish On The Economy, Means You’re Bearish On Housing

That said, if you’re bullish on the Canadian economy, you’re bearish on mortgage credit growth. As the economy strengthens, or is perceived to strengthen, interest rates climb sending mortgage rates higher. Currently the 5 year fixed rate, the most popular mortgage type, is at 4.99%. This number is projected to rise to 6.6% by the end of 2021. That seems like a small climb if you don’t deal with rates, but the 32.26% increase will have a huge impact on borrowing power.

The increase by itself, reduces that amount that households can borrow. For example, a household making $100,000 at the end of 2017 could have borrowed a $534,000 mortgage with decent credit. By 2021, a household earning the same amount, would see that number drop down to $448,000. The 16% reduction is based solely on the improvement of the economy, translating to higher interest rates. The stress test ensures this is the minimum qualifying rate.

Source: Parliamentary Budget Officer, Better Dwelling.

Incomes Rise, Median Household Still Loses Over 25% of Credit

Most households would ideally see their incomes rise, to mitigate some of this pressure. To demonstrate a more real world example, we can use median household income projections. At the end of 2017, it’s estimated that the median household across Canada could have borrowed $442,168. As their income rises, as well as interest rates, we project the median family would be able to borrow ~$399,627 by 2021. That’s a reduction of ~9.62%, so the rise of income does help mitigate some of the lost borrowing power.

Source: Parliamentary Budget Officer, Better Dwelling.

There’s limited use to applying projections to the median household across Canada. The only thing this really tells us, is there will be a significantly smaller national buying pool. That may be on top of the reduction we’re already going to see from stress testing, without an increase to rates. Sometime next week, we’ll apply this to more complicated models, to get a read on credit allowance for Greater Toronto and Vancouver.

Editor Correction: Jan 12, 2018 – 12:42 PM: The charts displayed were for a different mortgage model, and lacked two series. References to the missing series have been updated to reflect the change. 

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32 Comments

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  • Reply
    Mich 6 months ago

    Thank you for this. I’ve been saying since OSFI mentioned B-20 that it’s reckless to the economy. First time homebuyers can kiss their chances of homeownership good bye.

    • Reply
      Andrew 6 months ago

      “First time homebuyers can kiss their chances of homeownership good bye”

      Why is that?

    • Reply
      Oliver Clozof 6 months ago

      Maybe, but is keeping a big fat bubble more reckless?

    • Reply
      C 6 months ago

      More likely, speculators can kiss their big fat tax evasions games goodbye!

    • Reply
      MH 6 months ago

      First-time buyers (and all other buyers) will be much better off after prices returning to the sane levels in line with fundamentals. They will be able to pay for homes what it’s really worth paying for a place to live and raise families instead of assuming unmanageable amounts of debt.

      Canadian economy will be much better off too once it overcomes it’s self-destructive addiction to wooden/concrete boxes and starts investing in things that drive real GDP in 21st century.

      • Reply
        bluetheimpala 6 months ago

        here here. We need to kill this addiction to home building…it creates a false sense of security but when it comes crashing it hurts everything.

    • Reply
      bluetheimpala 6 months ago

      On the contrary. We need to normalize our economy, specifically housing, as it is out of whack. If prices come down to the levels noted in this article, based on current wages a lot of people will be able to buy a good starter home after saving in their 20s and early 30s. Then, through hard work and saving (maybe a little help from a small rate drop) they can move up. That’s how the model used to work…starter home and then move up. When a ‘starter’ is $650,000 that needs $100K then the market is f-ed up.

      • Reply
        Alex 6 months ago

        Exactly! There has to be pain from poor government planning over the past 3 years, and there’s no easy way to do it. Rip the band aid off now, deal with a small number of consequences, and get on with building a great country again.

    • Reply
      Dusty Hill 6 months ago

      If there is no firstimer, than the step up buy is not happening either. That will put the pressure on prices to actually adjust to conditions of the market. Simply if there is no buyer there is no seller, unless you realize that your 750,000 shag is worth only 550,000. Why would you think that firstimers are screwed? Is that because they are house horny and can’t wait no more? By historic standards and intl. accounting practices, the average price of the house has always been worth 3-4X the average family annual income. We are faaaar from that principle. OFSI as much as every attempt on every level of the government to extinguish idiot house prices is to save canadians from themselves.

      • Reply
        John 6 months ago

        I think you’re missing a fundamental fact. Housing is at the root, not an investment. It is a necessity of life which everyone must have.

        Unless humans stop reproducing, there will ALWAYS be first time buyers. If that means the market has to shift downward for them to get in, so be it.

        This is why it is pure nonsense that –Vancouver more so than Toronto– we have been feeding first time buyers handouts to keep them coming to market.

        Remove the credits, remove the rebates, remove HBP and let the market adjust to what is fundamentally affordable price.

  • Reply
    David M. 6 months ago

    I bookmarked the conversation you had on Twitter about Rob McLister, a huge mortgage broker, selling his place and becoming a renter. I show it to everyone that says this market is going up. When your mortgage broker thinks it’s a bad time, it’s a bad time to buy.

    https://twitter.com/SC604V/status/938298804243136512

    • Reply
      Ant 6 months ago

      Nice find. McLister is the guy from RateSpy, and is always discussing mortgages on BNN. He’s an honest expert. If he thinks Toronto is in trouble, there’s no reason to think otherwise.

  • Reply
    Oliver Clozof 6 months ago

    At what time between now and 2021 would say it is safe to assume the residential housing market is sustained solely by non-residents if we see prices stay constant or increase between now and then? For example, if rates gradually increase and B20 is implemented then the expectation is that a reduction of purchasing power will lead to reduced pricing (i.e. econ 101 supply vs. demand curve). However, when pricing does not decrease how long will be sufficient to state with a high probability of confidence that our residential market is entirely sustained by foreign acquisitions?

    • Reply
      C 6 months ago

      I would state with a high probability of confidence that our residential market is currently sustained by foreign acquisitions.

    • Reply
      C 6 months ago

      In fact, I’m 100% certain that the government has figured out that foreign buyers have corrupted our entire housing market and economic dependence on the housing industry.

      https://www.theglobeandmail.com/report-on-business/rob-commentary/what-toronto-and-vancouver-housing-data-do-and-dont-tell-us/article37562481/

      Current Canadian housing values have nothing to do with local economic fundamentals. NOTHING.

      And B-20 will only stop locals from crazy bidding wars, but not stop some foreign (read Chinese) from up-bidding and dumping housing.

      I guess we should all hope that when locals cant get into bidding wars with foreigners that prices will start to come down. Perhaps the foreigners will start to sell their “investments”, and you can go in and bid for a home based on local economic fundamentals-and be able to afford it, and the rest of your life, without getting into obnoxious amounts of debt.

      Doesn’t sound so bad after all, does it?

      • Reply
        Jim 6 months ago

        The best comment the most likely outcome. You took the words our of my mouth.

    • Reply
      Vince 6 months ago

      With the exception of the money laundering foreign buyers, most are just trying to make a quick buck. Right now you’re seeing them flip to locals, as in they’re leaving. In Vancouver, we’ve been warning this has been happening for years. They don’t want the houses, they know you’ll pay 20% more every year for them. They’re waiting until it’s no longer profitable. Capitalism at its worst.

  • Reply
    Trevor 6 months ago

    “if you’re bullish on the Canadian economy, you’re bearish on mortgage credit growth.”

    If you believe the housing market has (inflatedly) propelled the economy and are bearish on mortgage credit growth then you’re bearish on the economy, no? 🙂

    • Reply
      Tommy 6 months ago

      Great point, Trevor. If the housing market collapses, so goes the economy, too.

  • Reply
    Rosie 6 months ago

    I know this off topic, but would you mind elaborating on why your interest rate projections are lower? I can’t help but notice your use of the word “perceived.” Does that mean you’re seeing something other people aren’t talking about?

  • Reply
    Leo S 6 months ago

    > As of 2018, conventional mortgages are now stress tested 200 bps higher than the Bank of Canada’s 5 year fixed. Today’s qualifying rate of 6.99%, would see that household’s $534,000 maximum mortgage drop to $431,299 – a 20% reduction.

    What the heck are you talking about? Stress test is on top of contract rates, not posted rate.

    • Reply
      Dan The Mortgage Man 6 months ago

      Technically you’re both right. Conventional mortgages are 200 bps higher than the contract rate, or the BoC 5 year fixed rate, whichever is higher. The BoC 5 year fixed rate is going to be higher than you would likely find at any lender, and will always be the case. Don’t get confused on the tricky wording used by OSFI, there’s few options higher than the BoC 5 year.

      The good thing is if you find a lower rate, you will be saving much more money than previous generations had expected to pay on their mortgage.

      • Reply
        Leo S 6 months ago

        > Conventional mortgages are 200 bps higher than the contract rate, or the BoC 5 year fixed rate, whichever is higher.

        Just to clarify this. The stress test is at contract rate + 2%, or the BoC 5 year posted rate, whichever is higher. It is *never* BoC 5 year + 2% as indicated in the article.

    • Reply
      Beh G. 6 months ago

      I’ve hears this 20% number thrown out everywhere but doing the math, the number is actually as high as 37%!

      If you were to take out (i.e. could afford)a $100k mortgage in January 2016 w/ 25 year amortization and fixed 5 year mortgage at 2.39% your total mortgage payments would have been $443.

      If you take out a $100k mortgage now with the same amortization at 6.99% you will qualify for a mortgage of just over $63,000 (i.e. 37% less).

      And that’s before the now-almost-certain bank of Canada rate hike on Wednesday and potentially two more hikes later this year.

  • Reply
    Stop Foreign Speculation 6 months ago

    I know you only cover Torotno and Vancouver, but can you explain what this means for Montreal real estate? Foreign speculators are starting to increase, and it’s pumping prices. Thanks.

  • Reply
    Miguel 6 months ago

    How do we get the interest rate projections other people are getting?

  • Reply
    bluetheimpala 6 months ago

    I’ll add another horrifying layer I predict will happen…the boomer cohort, 65-80, is going to asset dump in the next 5-15 years.
    While everyone seems to think boomers will just ‘give the house to their kids’ that’s fine but the kids don’t want it and will sell. It is an inheritance. Anyone who took out money against their house, when the prices start coming down will HAVE to sell.
    2025-2030 could be a train wreck. Ride the cycle and get out in time.
    BD4L

    • Reply
      EO 6 months ago

      Great point. Boomers account for 9.6 million (+/-30%) of the population according to the 2011 census and seniors 65+ now out number children based on 2016 census numbers and that’s only going to grow.

  • Reply
    Juan Reyes 6 months ago

    If purchasing power goes down, prices should go down also. The government is implementing measurements to deflate the bubble in the long-term.

  • Reply
    Bri-Bri 6 months ago

    Does this mean long term compression of the Canadian real estate market? Also, can’t credit unions pick up the extra mortgages that fall out of the boat, since they aren’t regulated?

  • Reply
    Common Man 6 months ago

    I would like to add small experience, I lived in Argentina, Buenos Aires for 5 years. Price of real estate is ridiculously disconnected with the real state of the economy and purchasing power of a normal individual earning decent wages. USD$1= 15 pesos and Average studio apartment cost around USD $100K in Buenos Aires. Average salaries for young millennials are around 30K pesos/ month, the National average is 10K pesos/ month. Reason dirty money and foreign money. in the year 2011, 1 Peso was = $1 USD.
    Keep in mind, There are a lot of similarities between Canada and Argentina, the population of Argentina is same around 35 million, natural resources-rich country and majorly European population. Both allow, foreigners, to buy and sell properties and both allow FDI in natural resources including farming and much more, we all know at the rate Canadian gov is selling state-owned companies to a specific nation, same with Argentina.
    Remember the so-called foreign investors/ drug lords are using their dirty money to hide, they really don’t care how long they have to wait. If the market is majorly driven by these type of investors, except for prices of real estate to never go down. It may slow down but will never reduce. Hopefully, Canada is not another Argentina. The best solution is to go New Zeland way, stop all foreign and unaccounted investment in real estate and then only things will show real results unless based on local parameters no matter what we predict will always remain on papers and the Complete country will be like Vancouver.

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