If you're a dwell hunter in Toronto, and you're keen to lock down a piece of Toronto real estate, you already know it's extremely difficult to secure property. With the continued pressures due to a lack of supply, and even more Buyers entering the purchasing pool, competition is fierce and Buyers are pulling out all the stops. Yes, bidding wars have come back with a vengeance. Check out some of these recent Toronto real estate sales over the past 30 days in my post Getting On The Bidding War Bandwagon.
As prices continue to climb, it’s getting tougher for Buyers to stay within budget. However, recent changes to the mortgage stress test, and a recent drop in mortgage interest rates, could provide dwell hunters with a boost in their purchasing power at a critical point in the Toronto real estate year.
Just announced this week, the Bank of Canada drop in interest rates is a calculated move to offer stimulus in a tenuous global economy impacted by COVID-19, which has been wreaking havoc on global markets. For dwell hunters who are confident with their employment, this lower interest rate effectively means you can borrow more money and increase your purchasing power. Dropping interest rates in a frothy market doesn’t come without its risks though - both to household debt levels and to the economy in a greater context. I recommend you read "Bank Of Canada Rate Cut Will Put Already Hot Real Estate Market ‘On Steroids".
As for other policy-driven initiatives, here is what you need to know.
The New Mortgage Stress Test
After consulting with OFSI and the Bank of Canada, Finance Minister Bill Morneau announced changes to the mortgage stress test that will better reflect the changes in the market, centring on the benchmark rate. These changes will take effect on April 6th, 2020.
What do borrowers need to know? According to our friend and ally Mortgage Jake, for borrowers putting down less than 20%, the new benchmark rate will be the 4-week rolling average of the median 5-year fixed insured mortgage rate from mortgage insurance applications plus 2%, or the benchmark rate of 5.19% - whichever is lower.
“For uninsured mortgages (i.e. those with 20% or more down), another test change is expected by the regulators sometime in March. For now, those applicants will use the 5-year benchmark rate of 5.19%. Strange how lower down payment borrowers are benefiting from looser standards? The same thing applies to interest rates. High-ratio (5-19% down) borrowers borrow at cheaper rates. Why is this? Simple. Risk. You'd think that a 5% down payment borrower has more risk, right? Yes. Technically. In the eyes of the lender when that mortgage can be sold off to CMHC et al., the risk is mitigated, therefore the rate is lower. Definitely a concept that is opposite of common sense.”
While the theory of the mortgage stress test is sound (i.e. reduce debt vulnerability by forcing mortgage holders to build a sizeable cushion to absorb any financial shock from interest rate increase or income loss), the stress test as it stood wasn’t dynamic enough to respond to changes in the market. In fact, it effectively created an additional barrier for already challenged homebuyers trying to buy in pricey markets like Toronto. It also was presenting challenges for some highly leveraged homeowners looking to renew or refinance their mortgages.
According to this Financial Post article, “Why The Mortgage Stress Test Has Proved So Controversial For First-Time Homebuyers And Retirees” under the original criteria, purchasing power for some hopeful homebuyers shrank by up to 20 per cent. Indeed, the mortgage stress test has received a great deal of criticism from the public and from some policymakers. It was even a campaign issue in the recent Federal Election, which I discussed in my post: The Federal Election and The Canadian Housing Market.
So, for house hunters, how do these mortgage stress test changes impact their search? Mortgage Jake gives these numbers context:
"Effective April 6th, the rate will be +2% of the 4-week average rate. Using 2.79% as a typical 4-week average, therefore, we're at 4.79%. A $100,000 salaried borrower could borrow 5 TIMES their income.
So in this scenario, we went from $463,000 to $500,000 for this borrower or 3-8% more than today. Not bad, right? (Note - the range of 3-8% is to reflect the wide-ranging scenarios any Buyer may be navigating. For example, when purchasing a freehold dwelling only the annual property taxes are taken into consideration when qualifying the Buyer's purchasing power, whereas if they're purchasing a condominium both the annual property taxes and the common fees become part of the calculation for qualifying the Buyer).
At a time when the market is absolutely ripping in our part of the world, this will help a tiny teeny little bit. On one hand, this is the change the Government is going to say "see! Look! We listened!" On the other hand, this is the change that will have a very nominal impact in 99% of cases. Same with the "shared equity" program (outlined below), which only helps the very few people out there who need to go to the absolute maximum in locations where real estate is less expensive than Toronto."
Here is the Government of Canada Press Release about the new stress test.
Other Federal Support
First-time homebuyers can take advantage of additional support by way of programs and tax credits. It’s even harder for first-timers to gain a foothold in a pricey market, so these can be helpful.
The Home Buyers Amount lets first-time homebuyers claim $5000 on a property which qualifies when filing their annual taxes.
The First-Time Home Buyer Incentive (FTHBI) is a shared equity program recently created and sponsored by the Federal Government. The government provides either 5 or 10 per cent of the purchase price of your home (depending on if it is a new build, resale or mobile home) as part of your down payment. You must repay this amount within 25 years or when the home is sold (whichever comes first). You are also free to repay at any time. The incentive is available to first-time homebuyers with qualified annual incomes of $120,000 or less. A participant’s insured mortgage and the incentive amount cannot be greater than four times the participant’s qualified annual income. Given the cap of housing prices under this program - which at most is around $565,000 - there have been questions about its efficacy for first-timers trying to buy in Toronto!
Creating Dangerous Debt Conditions?
Having the ability to stretch your dwell hunting dollars further is good in the sense that it helps you to achieve the immediate goal of homeownership. However, does overleveraging yourself with debt make sense in the longer term? Also, there is also the issue that giving homebuyers the ability to pay more is going to fan the flames of price appreciation as well. Sellers who don't plan on moving anytime soon are going to like the increase in equity this provides.
However, as we've seen over the past few years, if people are able to borrow money in this market, they will. As a result of living in an extended period of ultra-low interest rates, a persistent lack of housing supply and feverish market psychology is driven in part by the fear of missing out, Buyers have largely developed desensitization to debt. The higher the market goes, the willingness to pay top dollar grows as well and more people are willing to use debt as a means to an end.
This was part of the reason that the mortgage stress test was introduced in the first place, as policymakers became increasingly concerned about the rising levels of household debt. When people are leveraged to the max, there is little room to absorb interest rate increase or other financial changes. The feeling was that even a modest change in the economy could trigger a financial crisis.
While it is true that having a great deal of household debt does create financial vulnerability, a new study suggests that it isn’t the measure of debt itself, but the measure of a household’s ability to service that debt that is a more accurate indicator and that with current household debt levels, the risk is relatively low. Research Group CD Howe recently wrote a report called” “Predicting Financial Crises: The Search for the Most Telling Red Flag in the Economy”.
In their press release, the group said, “Using a new financial vulnerabilities barometer, the authors show that that inclusion of household debt servicing considerably improves the barometer’s ability to track financial vulnerability, particularly in advance of recessions. In contrast to the Bank of Canada’s financial vulnerability barometer, their index declines sharply after the Great Recession and, while there is some indication that debt servicing is on the rise, financial risks remain low.”
The authors also point out that an uptick in borrowing has a short-term economic benefit, but that as household debt continues to accumulate, an individual household’s ability to service that debt is diminished, which creates the financial vulnerability and raises the risk of a wider financial crisis.
It’s true that net worth has increased a great deal in Canada over the past decade, due in large part to a large increase in real estate values. However, that wealth is eroded when the gap between what you own and what you owe decreases.
For more insight on the CD Howe report, read "Bank Of Canada Has It All Wrong - This Is The Real Red Flag To Watch For In The Economy" and "Debt Servicing Is A Better Metric For Measuring Financial Risk, Report Says".
In order to maximize your return on your real estate investment, it makes the most sense to use mortgage debt as part of an overall, longer-term strategy to grow your household wealth, which includes long-range planning around equity takeout from your investment, as well as paying down your debt.
That’s one thing that many people forget, is that real estate is a leveraged investment with variable-namely interest rates and market volatility. Now more than ever, it is crucial to engage a prudent, well-researched strategy when buying a home.
With 28 years navigating Toronto’s real estate trenches, may I and my team offer our experience and gently guide you on your best path forward?
We are here to help!
*** ADDENDUM *** MARCH 13th, 2020 ***
In light of COVID-19 continuing to spread, and harsher national sanctions upsetting the stock market, Mortgage Jake sent us a important financial updates, with his comments interspersed:
• Stress test is pushed back until normal financial conditions resume.
"Good decision by the Ministry of Finance. NO WAY do we need to make changes at the moment."
• Bank of Canada another 1/2% drop - more to come.
"Not surprised by the timing. I knew we wouldn't be waiting until the 6th. I expect variable rates to drop (Prime) but I expect discounts to prime to go UP (in other words, get worse)"
• Fixed rates maybe going up.
"One bank - Scotia - has signalled this could happen very shortly. Ouch. Not surprised, I did say earlier that if margins are too tight it doesn't matter what's happening in the bond market - rates will rise because banks have to keep their margins."
• It's a crazy time. Be calm, be steady, and try and keep a level head.
"And most important, be safe."
*** ADDENDUM *** MARCH 25th, 2020 ***
• CMHC and Genworth and Canada Guaranty - all three major mortgage insurers, announced that all applications approved by today will be guaranteed to close even if there is an employment loss.
"That's great news! There are stipulations, of course: When was it approved? Are all conditions met? And is it closing prior to September 30th 2020? If yes, yes, and yes, your borrower is fine. Provided they have LESS-THAN 20% down (because those loans are guaranteed by CMHC et. al.)
• Regarding mortgage relief, there are scores of people calling their lenders, wanting at least temporary releif. While most banks are doing it "case-by-case", finally two lenders (RFA and Scotiabank) have launched an online portal to help people apply online for relief.
RFA/Street Capital (A much smaller lender): https://www.rfa.ca/COVID19
"It's only a matter of time until most/all lenders do this because although it'll maybe take them longer to reply, they will have a much more organized process. Each lender seems to be doing it a bit differently. No matter what the interest, it will keep getting accrued. Will they add it to the end balance at maturity OR roll the interest into your payments over the time of the mortgage? Answer: It depends! On the lender."
• Interest rates are going up - again!
"We're going to cross the 3% 5-year fixed mark. Variable rates are now Prime+ rather than Prime, with almost all major (good) lenders. In 2008 when variable became Prime+, it still made some sense to go variable (1. the penalty 2. the ability to lock in). I'm a fan, still, but only if/when BoC drops rates (and if lenders will follow)."
Thank you Jake! We always value your advice, especially at a time like this when the economy is in turmoil!
If you're interested in learning more about the Toronto market through our lens, consider reading some of my other posts:
May my team and I become your realtors of choice, and guide you to the best of the best Toronto real estate as it meets your wishes, wants and needs?
Thanks for reading!
-The Urbaneer Team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
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