The WealthBridge Blog

If you had to earn a living predicting home prices and could use just one indicator to do it, which would you choose?

“Affordability is a key variable. It gives you a lot of information,” says CIBC deputy chief economist Benjamin Tal. “When affordability is good, demand usually exceeds supply.”

Affordability – a type of debt service ratio – gauges the average percentage of income needed to carry a mortgage. This is closely linked to how much homeowners can borrow.

It’s a rather paradoxical statistic. You would think, for instance, that with home prices doubling in the last 10 years, affordability would be getting worse.

But with soaring debt levels, doesn’t it seem counter-intuitive that folks could “afford” such elevated home prices? It might, but affordability doesn’t measure home prices or total debt.

Low rates have been pivotal for consumers. They’ve kept interest payments, as a share of disposable income, at just 7.2 per cent, Mr. Tal says. That is below the long-term average of 7.6 per cent and well under the 10.7 per cent level from 20 years ago.

Cheap rates have also supported bigger mortgages. If we look at mortgage payments from two decades ago, a typical single job holder with 10 per cent down and minimal consumer debt qualified for a $96,000 mortgage.

Today, he or she could get a $285,000 mortgage - almost three times as much.

(This assumes a 25-year amortization and standard lender assumptions for debt ratios, property taxes and heating costs. It uses Statistics Canada data for wages and estimates of five-year fixed mortgage rates based on Bank of Canada data.)

That might be little consolation to folks living in places like Vancouver or Toronto, which are exceptions to affordability. But the fact remains that overall, low rates give borrowers tremendous leverage.

Leverage is something the Bank of Canada is understandably concerned about. Cheap money means “cheap” debt payments, and it’s awfully easy to get complacent.

When rates do eventually take the elevator up, real estate is going to feel it.

House prices will almost certainly roll over when interest rates rise, BMO senior economist Sal Guatieri said in a recent report.

“A 2 per cent rate increase would put enough strain on affordability to slow the market meaningfully,” he said. “It would encourage many first-time buyers to just rent.”

2012 CMHC Survey

These are some key findings from this year’s CMHC Mortgage Consumer Survey.

This always-intriguing report also highlights continuing trends in online interaction, particularly:

  • the emergence of social media as a tool used by mortgage consumers, and
  • growth in do-it-yourself mortgage research.

Mortgage Research

71%: of consumers researched mortgages online, up from 65% in 2011. (Somewhere down the line we’ll see this number in the 90% range.)

31%: relied solely on the Internet to gather mortgage-related information. (This is up from 22% last year, and further indication that consumers are increasingly taking mortgage research into their own hands.)

Mortgage broker share

27%: of mortgage consumers used a mortgage broker to arrange their mortgage in 2012, vs. 23% in 2011. (This is a record high according to CMHC. Key reasons for using a broker continue to be “getting the best rate or deal” and “receiving excellent service,” say CMHC.)

Broker share of mortgage originations:

  • 48%: among first-time buyers (Almost half of young buyers are choosing brokers, versus 35% five years ago. That’s despite brokers’ marketing budgets being microscopic compared to the banks.)
  • 32%: among repeat buyers
  • 27%: among those refinancing.

Loyalty to Lenders

88%: of renewers continue to remain loyal to their existing lender. (This hasn’t changed much since 2009. Lenders continue to do everything they can to retain clients at renewal.)

59%: of first-time buyers reported getting their mortgage with the financial institution (FI) they were dealing with the most, vs. 47% in 2009. (This is a significant increase. FIs know the value of a young buyer and are being aggressive in courting their existing young customers.)

New Mortgage Regulations Coming Soon

Many of OSFI’s proposed mortgage underwriting guidelines may be coming soon to a bank near you.

An OSFI spokesperson told us on Wednesday, “We are still aiming for a late June (or) early July release.

OSFI says the guidelines will come into force sometime after they are released, but it didn’t have a timetable yet. We get the sense it won’t be too far down the road.

OSFI also noted that it talks to financial institutions regularly, and told us they are “prepared” for what is coming.

Proposals being considered could require banks and federal trust companies to:

  • Make borrowers prove they can afford higher rates, even if they have large down payments
  • Eliminate cash-back down payment mortgages (effectively 100 per cent financing)
  • Make self-employed borrowers show more proof of income
  • Restrict use of interest-only secured lines of credit
  • Use more conservative debt ratio tests

Rates Increasing Unlikely Any Time Soon

Now, the fear out of Europe has pushed borrowing costs to unsettling levels. The most glaring example is Canada’s 10 year yield which made an all-time low today. What’s more, traders have now completely priced out any chance of BoC hikes in the next 12 months.

The upshot: Lower yields mean lower fixed-rate funding costs. As a result, we’re starting to see alluring rate cuts.In fact, almost every bank cutting rates this week refrained from publicly advertising cheaper discounted rates. Their press releases announced only posted drops, which is unusual on such a wide scale.

The only exception was BMO which had the conviction to advertise a lower 5-year discounted rate at 3.39%.

With or without hoopla, rates are dropping industry-wide. In the broker channel, Scotiabank published its lowest 5-year rate ever at 3.19%. In the retail channel, we’re hearing bank specialists quote comparable rates on a “discretionary” basis.

Hence, despite Flaherty’s apparent efforts to slow mortgage discounting, it looks like we’re headed right back to near-3%-land on 5-year money. The rate market is no one’s puppet.

Retiring with a Mortgage?

The one thing Canadians won’t be retiring anytime soon is their mortgage debt, according to a new survey.

Bank of Montreal says 51% of Canadian homeowners plan to carry their mortgage into their retirement years.

“It’s a phenomenal number I think,” said Tino Di Vito, head of the BMO Retirement Institute.

‘People are more sophisticated in their approach to personal finance today than the previous generation’ But Phil Soper, chief executive of Royal LePage Real Estate Services, said times have changed and he believes Canadians can handle the burden.

“People are more sophisticated in their approach to personal finance today than the previous generation,” says Mr. Soper. “People are living longer, working longer and making real estate plans longer or further into their lives.”

Another trend, one which was not considered by the industry before, is people moving into more expensive, upscale homes after retirement. “Traditionally people paid off their mortgage and people lived in their home until it was time to downsize,” he says. “It’s not necessarily a dangerous trend.”

Another part of the trend could very well be strategic. With rates on a five-year closed mortgage at about 3.5%, paying down that debt might not seem as high a priority for many homeowners. That logic might not be so sound, says Doug Porter, deputy chief economist at Bank of Montreal.

“The extremely low level of interest rates is acting both as an inducement for people to take on more debt than they would have in the past and on the flipside not encouraging them to save as in the past.”

People could end up working longer and it might also mean there will be that much less equity in the home you’ll be leaving to heirs.

The attitude of homeowners could also reflect the longer amortizations the mortgage industry saw before the government cracked down on the rules, Mr. Porter said.

Traditionally, mortgages were amortized over 25 years, but that number ballooned to 40 before Ottawa twice lowered the limit, which now stands at 30. Many are calling for it to be reduced back to 25 years.

Ms. Di Vito says the issue is how it’s affecting retirement with half of Canadian homeowners saying their debt load was hindering their ability to plan and save.

‘Carrying debt into retirement is a threat to financial security’“ Carrying debt into retirement is a threat to financial security,” says Ms. Di Vito, who believes Canadians need about 70% of their pre-retirement income to maintain the same lifestyle. “That assumes other expenses such as mortgages are already taken care of.”

She says half of Canadian homeowners age 50 to 59 still have mortgage debt based on Statistics Canada information. By 60 to 69, 25% of those people still have a mortgage.

It doesn’t help that real estate prices continue at all-time highs. The Canadian Real Estate Association said this week the average home price reached $372,608 in April. In Vancouver, even though prices dropped almost 10% year over year, the average sale price in April was $735,315. Almost 60% of B.C. homeowners expect to take mortgage debt into retirement.

Author Talbot Stevens wonders how people will survive in their retirement.

“People get a hold of a line of credit and they spend $40,000 on upgrading their home. At least with that, you have something to show for it, maybe 40¢ on the dollar,” says Mr. Stevens, who worries about more frivolous spending. “We really have to be more responsible with debt and what we are using it for.”

 For most Canadians their home is the biggest investment they’ll ever make — but they might be surprised to learn you can use if for more than just sleeping.

People generally don’t think of their homes as a potential pile of cash in the bank, but experts say it’s something worth pondering now that home prices in Canada may have hit their peak.

In fact, analysts say if finance is the only consideration, conditions now and into next year or so form a seldom seen sweet spot for using home equity as a type of asset for investment.

Why might it be a good time to sell?

At about $370,000 average nationally — and just under $800,000 in Vancouver — home prices are already at record levels. Many observers believe prices are long due for a downward correction of anywhere from 10 per cent to 25 per cent, perhaps more in some of the hottest markets.

“Home prices to income, housing price to rent, all the indicators are setting off warning signals,” said Derek Burleton, a senior economist with TD Bank.

“If you are purely in it for reaping profits, now is not a bad time to sell” before prices drop.

The profits from selling a home can be used to build savings, eliminate debt, make traditional investments or, ironically, buy more real estate — albeit in a different market where home prices are lower.

Of course, even if it makes sense financially, selling the family home to rent or move to a less expensive housing market doesn’t make lifestyle sense for the vast majority of Canadians.

Burleton knows how they feel.

“I wouldn’t want to sell my home right now even if I wind up taking a hit on the home price, just because I enjoy where I’m living and moving is a pain,” he said.

While there’s no guarantee of a correction, observers note there are additional signs that the housing market could cool off in a big way.

With ownership levels near a record 70 per cent, demand is expected to wane, making it a buyers market for the first time in years.

And Bank of Canada governor Mark Carney warned last month he was preparing to hike rates, which along with tighter lending rules being applied by federal authorities could trigger a flight from real estate.

In market terms, selling a home at the peak is a way of “locking in” profits accumulated over the past decade of price appreciation — and tax free if it’s the principal home.

Meanwhile, home valuations have been rising far faster than the rent they would fetch since at least 2000. Canada’s home price-to-rent ratio is well above historic norms and among the highest in the advanced world.

That is a hard indicator that homes are over-valued, but also that renting is relatively cheap compared to buying.

David Madani of Capital Economics, who anticipates a 25 per cent price crash over the next few years, cautions that like selling stock shares, timing is always tricky.

“We’re dealing with irrational exuberance. We’ve been treating housing like some magical financial asset that is going to solve all our problems because prices are always going up,” he said.

“Of course, when the turn comes, the over-confidence that drove the market up can turn to fear. You are dealing with emotion … so I don’t believe in a soft landing.”

The market is clearly at or near peak, he said, so soon may indeed be the time to act.

But then again he felt that way a year ago, he points out, and if households had acted on his advice they might not have gotten all the value they could from the premature sale.

Bank Bailout Higher Than Most Think

Canada’s biggest banks accepted tens of billions in government funds during the recession, according to a report released today by the Canadian Centre for Policy Alternatives.

Canada’s banking system is often lauded for being one of the world’s safest. But an analysis by CCPA senior economist David Macdonald concluded that Canada’s major lenders were in a far worse position during the downturn than previously believed.

Macdonald examined data provided by the Canada Mortgage and Housing Corporation, the Office of the Superintendent of Financial Institutions and the big banks themselves for his report published Monday.

It says support for Canadian banks from various agencies reached $114 billion at its peak. That works out to $3,400 for every man, woman and child in Canada, and also to seven per cent of Canada’s gross domestic product in 2009. The figure is also 10 times the amount Canadian taxpayers spent on the auto industry in 2009.

“At some point during the crisis, three of Canada’s banks — CIBC, BMO, and Scotiabank — were completely under water, with government support exceeding the market value of the company,” Macdonald said.

To show the scale of the funding, the CCPA report contrasted the total value of the support Canadian banks took against the bank’s total value at the time. Under that comparison, CIBC received $21 billion in support — almost 1.5 times the value of the company at the time. BMO maxed out at $17 billion or 118 per cent, Scotiabank peaked at $25 billion or 100 per cent of its value, while TD and RBC maxed out at $26 billion and $25 billion — good enough for 69 and 63 per cent, respectively, of the total value of those companies at the time.

“It would have been cheaper to buy every single share in these companies,” Macdonald said, “Without government supports to fall back on,  Canadian banks would have been in serious trouble.”

OSFI Regulates CMHC

Ottawa moved to bring the Canada Mortgage and Housing Corporation under the purview of the country’s top financial regulator Thursday.

Finance Minister Jim Flaherty outlined the proposed changes to Canada’s national housing agency in a wide-ranging bill tabled in parliament on Thursday.

The CMHC insures the vast majority of Canadian mortgages, as well as guaranteeing mortgage-backed securities issued by Canadian banks. It is backed by taxpayer dollars and under current rules, is governed by the Department of Human Resources and Skills Development Canada.

But the changes outlined Thursday will give the Office of the Superintendent of Financial Institutions — the top financial regulator in Canada — and the Department of Finance ultimate authority over CMHC’s actions.

OSFI is the regulator ultimately responsible for all federal financial institutions in Canada, including 149 deposit-taking institutions such as banks, 308 insurance companies and 1,200 pension plans across the country.

To this point CMHC didn’t fall under its supervision because it has grown exponentially over the years. Its assets have grown by more than twelve-fold in the decade between 2000 and 2010.

“It is a recognition that CMHC has become a significant financial institution,” Flaherty said. “CMHC was created to assist in social housing [but] it’s become much more than that.”

Mortgage-backed security oversight

The bill also calls for the establishment of a registry to monitor how many mortgage-backed securities known as covered bonds that Canadian lenders have outstanding.

When banks give out mortgages to customers, they often get them off their balance sheets by bundling them together and selling them off. That gets their capital ratios — the amount they are allowed to loan out compared to how much cash they have on hand — back to allowable levels, which in turn lets the banks issue even more mortgages to customers.

“There’s some debate about what should be allowed to be in that envelope,” Flaherty said.

There has been concern in recent months that the securitization of mortgages is exacerbating a growing debt problem in Canada.

CMHC has been bumping up against its $600 billion limit of how many mortgages it is legally allowed to insure in part because the CMHC has taken on an increasing amount of mortgage-backed securities from Canada’s big banks.

The federal government has already moved to tighten the rules for who can obtain a CMHC-insured mortgage twice in the past two years

Rates May Rise In 2012

The Bank of Canada held the line today and left the country’s pace-setting overnight rate at 1%.

 The news, however, is not what the BoC did, but what it hinted at doing.

 Governor Mark Carney and co. jostled expectations in their prepared statement, which said:

 •“Overall, economic momentum in Canada is slightly firmer than the Bank had expected in January.”

•“…The economy is now expected to return to full capacity in the first half of 2013.”

•“…The profile for inflation is expected to be somewhat firmer than anticipated.”

•“Europe is expected to emerge slowly from recession in the second half of 2012”

•“In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”

This last point, in particular, has put the bond market on edge. As of this writing, 5-year yields are up seven basis points since this news broke, and up 10 bps on the day. (Bond yields lead fixed mortgage rates.)

 Prior to this morning’s announcement, the market expected the Bank of Canada to move rates in early 2013. We could now start seeing some economists shift rate hike predictions to Q4 of this year. BMO has already moved up its forecast by six months to year-end 2012, according to BNN.

 The BoC will still want to see more data before pulling the trigger, however. Canada remains tightly constrained by cautious U.S. growth, and that growth has had a funny habit of disappointing after optimistic spurts in the spring.

Home Equity Lines of Credit Restricted to 65%?

There’s a good chance we might see new restrictions on HELOCs, possibly within the year.

Last week, Canada’s top banking regulator Julie Dickson explained why to BNN:

“We started to see [HELOCs] being used as a substitute for a mortgage. Instead of having a mortgage on a house, you had a HELOC only, and that is not what these HELOCs were designed for originally. That’s why we suggested in the guideline strongly that there be a loan-to-value ratio of a maximum of 65%.”

“We want the (underwriting) practices at the banks buttoned down,” Dickson added, saying that some financial institutions were not following underwriting policies “to a T.”

As with OSFI’s other pending mortgage guidelines, the new 65% LTV HELOC change is up for public comment until May 1.

The Downside…

If OSFI were to impose this 65% LTV limit on all borrowers (regardless of qualifications), some would view it as one of the most over-reaching consumer lending rules OSFI has enacted; painting all borrowers—strong and weak, responsible and overleveraged—with the same brush. Hopefully exceptions will be made for strong borrowers.

It’s vital to note that HELOCs support a host of valid uses. Many people rely on them for investing purposes, educational borrowing, contingency funds, value-added renovations, etc. Moreover, unlike high-ratio mortgages, HELOCs present no taxpayer risk because they’re not backed by the government. They also impose minimal insolvency risk to banks, to the extent that borrowers are well-qualified and maintain 20%+ equity.

On a related note, OSFI’s draft guidelines suggest it might also require federally regulated institutions to limit interest-only periods on HELOCs to five years. This would be a senseless restriction for people who use HELOCs for retirement planning. In such strategies (e.g., the Smith Manoeuvre), interest-only payments and 80% LTVs are sometimes essential. In these cases, HELOC borrowing is generally offset by the income-generating assets purchased with those funds.

Regarding the recent 2.99% mortgage “sales,” Dickson said it is “very important” to make sure consumers “can not only pay a 2.99% (rate) but can actually pay the 5-year Bank of Canada posted rate.” It’s not a coincidence then that OSFI’s proposed guidelines talk about using the 5-year posted rate to qualify a much broader range of borrowers.