More on the mortgage rule changes…

The announced mortgage rule change has generated a great deal of coverage in the media and general interest among the public.  Yesterday was the busiest day this blog has ever seen, with a huge influx of new readers who stumbled on this site while searching for more information about the rule changes.  Yesterday saw a tripling of visitors who found this blog via a search engine.

I’m not sure whether it is nothing more than an information search or whether it represents a tangible sense of worry for many home owners.  The search terms that landed people on this lowly blog were perhaps telling.  By far the majority were looking for answers on just how the new mortgage rule changes will affect house prices.

I don’t have a crystal ball, but I can assure you that despite the possibility of a temporary jump in sales over the next couple months, there is nothing in this new rule change that will add buoyancy to the market beyond the next 60 days.  But it certainly adds some significant headwinds.  Let me toss out several unanswered questions I have about just how these rule changes will affect the broader market.

1)  Just how significantly will this shrink the buyer pool?

As I suggested yesterday, this will certainly squeeze the buyer pool at the margins.  However, I’m increasingly convinced that marginal buyers were providing the bulk of the  momentum in the current housing market.

For the past six years in Canada, real estate has been largely supported by a fairly continuous loosening of mortgage terms.  Sure Flaherty undid the 0/40 screw-up, but the fact remains that mortgage insurance went from a 10 percent 25 year am standard to 5/35 as of yesterday.  Add in the impact of emergency interest rates and you have a housing market that has the appearance of strength while at the same time relying on increasingly marginal buyers who only a few years ago would have been forced to sit on the sidelines until they could qualify for a taxpayer guarantee on their mortgage.

Without getting into a discussion about the incredible injustices involved in asking someone to put some of their own skin on the line before taxpayers guarantee the full loan, let’s just note that these policies have had the net effect of pulling demand forward by allowing people who otherwise would not qualify to suddenly be able to access a mortgage.

In some ways the average consumer shares the same mentality as water flowing down a hill.  They both look for the path of least resistance….the easiest route.  Taking a 35 year amortization does not necessarily imply that a buyer is marginal.  In many cases it’s just the easiest route.  It frees up a bit more cash over the short term while guaranteeing tens of thousands extra in interest payments.  They may not be wise, but they’re also not necessarily the buyers we’re concerned about.  Just how many of these marginal buyers have just been priced out is a huge question, but it may be more than we think.

Yesterday Rob Carrick wrote about mortgage broker who fully supported the rule changes.  According to John Cocomile, a mortgage broker in Toronto, 90% of all new mortgages originated in his office were for amortizations of 35 years.  That option is now gone.

While I don’t at all suggest that Mr. Cocomile’s experience is necessarily representative of the rest of the country, I am also certain that CAAMP’s data does not represent reality.  By way of refresher, CAAMP calculated that 30% of all new mortgages were originated with 35 year ams.  As I pointed out, this is aggregate data representing all new mortgages.  The important data point would be the number of first time buyers accessing mortgages with 35 year ams, as pre-existing home owners who are ‘trading up’ would logically take lower amortization lengths on average.

So with the 35 year amortization option now gone, the maximum funding available to the average home buyer just shrank by 5-10% while the average mortgage payment just rose by over $100 a month.  BMO Nesbitt Burns deputy chief economist Douglas Porter suggested that resale prices could drop as much as 7 per cent within the next 12 months as a result of these new rules.

Pretty hard to disagree with Porter’s statement.  With stable demand and stable supply, all things being equal house prices in Canada will decline by about 5-10% just to compensate for the lack of new credit to keep prices buoyant.  But that’s a huge assumption that supply and demand will remain stable.  And that brings me to my next big unknown.

2)  How will the new mortgage changes affect supply and demand?

The last six months have been characterized by a joint buyer and seller strike as can be seen at the tail end of the following chart.

You’ll see that new listings have fallen at a rate only equalled by the miraculous 2009 emergency interest rate-induced market.  But unlike that market, which saw the return of widespread bidding wars for sparse properties, this market has not seen the same rebound in sales activity.  November stats held some promise as sales rebounded, but December was a different story.

The big question is where did all this inventory go?  No doubt sellers have the memory of the last great government-induced rebound in demand in the back of their mind.  Perhaps they are anticipating another rebound in demand and price as the anomolous 2009-2010 housing market solidified the notion that short periods of turbulence in the housing market are to be followed by periods of great strength.

But this time is different.  Rather than bailing them out, the government has slapped them upside the head.  Rather than move to create additional demand, they’ve moved to destroy it.

This reality has probably not yet sunk in, but remember that mass psychology nearly assures that reversals in sentiment happen rapidly and can quickly ingrain in large swaths of the population.  If sellers are holding out for the anticipated rebound, stories like this will certainly shake their confidence:

Will mortgage rules add chill to a cooling market?

Soft landing for housing far from certain

If the holders of this shadow inventory are holding out for expected gains in price and/or demand, how will they react when the likelihood of those gains are called in to question?  The next three months will be pivotal in determining whether this will be the start of a long, slow drain on housing, or whether it will mark the beginning of a rapid realignment of house prices with fundamentals.  If sellers re-list en masse while demand grows only marginally or flat-out declines, look out!

3)  How will it affect credit conditions and the broader economy

One of the topics I discuss often is the role of real estate in generating massive amounts of credit that permeate our consumer-driven economy and give the illusion of prosperity and economic growth.  There is a powerful feedback mechanism between house price increase, consumer confidence, consumer spending, and economic growth.  I have written about this in detail on many occasions.

The bottom line is that lines of credit have become the drivers of a significant component of consumer spending in our economy.  CAAMP data suggests that home equity withdrawals have goosed the after-tax income of the average family by 9%.  This is money that flows directly into consumer spending.  This flow of money is now under threat.

Traditional HELOCs will come under pressure as house prices adjust to the reality of less credit entering the system and are repriced to the down side.  As I’ve shown many times, home equity withdrawal is highly correlated with house price movement.  Here is the American experience.  The bars show the amount of money withdrawn from home equity.  Can you guess where their home prices turned negative?

This is a huge concern for consumer spending, which accounts for 65% of GDP.  By extension, this is a huge concern for the broader economy.

The new rule changes don’t specifically target traditional, non-insured HELOCs.  Rather they target the CMHC-backed products.  While most institutions do not insure their HELOC portfolios, it doesn’t mean the impact will be negligible.  As this article in the Globe noted:

“Gerald Soloway…The head of Home Capital Group Inc., which has about 40,000 mortgages in Canada, says the mortgage-backed lines of credit were originally intended to help people make improvements to their homes. The reality, however, is “it became an ATM for weekend recreation.”

And by extension this excess credit creation has buoted segments of the labour market that would not otherwise have flourished.  Hence, unemployment is always low at the tail end of a credit bubble, but stubbornly high once it pops.

The new mortgage rule changes will not end the flow of insured LOCs, but it will strap them to an amortization schedule making them more burdensome for consumers.  If demand for lines of credit drop sharply as a direct or indirect result of these new rule changes, we’ll very quickly understand the significance of unintended consequences of government policy on the broader economy.

4)  Will 40 year am mortgagees be stuck at renewal time?

One question that has been discussed with no definitive answer is what will happen to those people who made use of the zero down, 40 year am mortgages when they come up for renewal.

While the CMHC guarantee remains, what is unclear is exactly how these mortgages will be handled by the original lending institution.  Certainly they will be renewed provided the payment history is unblemished, but what will the new amortization be?  And will they be locked in to the posted rate as their bargaining power has evaporated?  If so, how will this strain their finances?

Oh so many questions.  I have little doubt about the directionality of the market over the next few years, but the rate of change will be determined by the response of buyers and sellers in that time.  The next 60 days will be the most significant for the housing market in many years.  Keep your ear to the ground.



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14 Responses to More on the mortgage rule changes…

  1. Jordan says:

    Conveniently, the changes were announced at about the mid-point of the month. It will be fascinating to compare the sales and listings numbers in the “front” and “back” halves of January 2011 to the corresponding periods in January 2010. The statistics of the housing market from now until mid-year will give an interesting perspective on the psychology that lies behind it.

  2. Nick says:

    I’m happy for you and the new traffic to your blog. It is always worth a read and I like receiving the posts by email. Keep up the good work!

  3. Alex says:

    I haven’t decided whether the Cons. Gov’t wants to stave off a collapse before their forced by the Libs into an election or are willing to collapse the market and try and be the saviours. I’m leaning towards the later as I put nothing past this parasitic Conservative regime who are more like there Republican counterparts than the Progressive Conservatives of Joe C. Don’t get me wrong I’m a life long PC supporter but this isn’t my party, this party was bought by the oil interest the banks and big business. Please please let there be a viable Liberal alternative if were forced to hold our noses and vote. Great job as always Ben with your last few posts.

    • Nick says:

      You’re right, they are nothing like Joe C. They are running, for better or worse, a successful minority government.

      • HHV says:


        (Ben, the quickest way to kill a housing/finance related blog is to let it degenerate into a discussion of competing politics)

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  5. John in Ottawa says:

    Further to Ben’s topic today, there has been a lot of discussion everywhere about a possible surge in sales over the next two months as buyers attempt to lock in a 5/35. But what price should buyers be willing to pay?

    The general consensus forming from economists and bloggers alike, is that house prices will drop by anywhere from 2% to about 8% this year as a result of this mortgage tightening.

    However, I read that many people believe the drop in prices will happen after March 18, not before. Indeed many people believe the “surge in demand” will drive prices up over the next two months and many listings will come online to take advantage of the higher prices. In other words, once again demand will be brought forward.

    If prices rise over the next two months, it will demonstrate just how irrational markets can be. We have perfect information as of two days ago, that demand for housing is going to be reduced. That, after all, was the point of the announcement.

    When a demand reducing announcement is made, the demand curve shifts immediately. The market has perfect information about the future. Any purchaser who is contemplating a 5/35 at price P, will in two months only be able to afford a 5/30 at price P’ where P’ < P.

    Thus the class of housing that was in the sweet spot for 5/35 purchasers at price P will immediately shift to the lower price P'. It would be irrational to pay the higher price just because cash flow would allow it. Consider the possibility that prices go down 7%. That 5% down payment is gone and the house is under water.

    The rational thing to do is offer P' now, even if a 5/35 can be locked in. The windfall is taken by the buyer as "economic rents." Otherwise, wait until the price is forced by the drop in demand down to P'. The cash flow at 5/30 may be very similar to the cash flow that would have occurred at 5/35 simply because of the lower price.

    Exactly where P' ends up will have to be determined in the fullness of time. However, it is clear that, all things being equal, P' is less than today's prices. Paying a premium to lock in a 5/35 mortgage today is irrational.

    • Jordan says:

      And this is why a biweekly (or weekly, if available) look at listings, sales and prices over the next few months will be very interesting.

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