The fantasy of endlessly rising house prices is over.
If the housing market doesn't respond to measures announced by the federal government on Monday, then expect more action ahead. Argue all you like about how economic and real estate fundamentals affect prices. In the end, it's government action that will bring housing to heel.
Thank god for some adult supervision in housing. We need it for all the people who are basing the biggest financial move of their lives on the idea that houses always go up in price. Ideally, government intervention today prevents a painful correction ahead.
A lot of people are torqued about the influence of foreign buyers on our hottest housing markets, and the feds did target this group. But a measure with much wider applicability is the stricter enforcement of a mortgage rate stress test that people must take if they have a down payment of less than 20 per cent and therefore must have mortgage default insurance.
You now have to take this test if you're in this group and want a variable-rate mortgage or a fixed-rate mortgage with a term under five years. Starting with mortgage insurance applications made on Oct. 17 and thereafter, fixed-rate mortgages of five years and longer will be included as well. Mortgage broker David Larock said two-thirds of borrowers today are going with the five-year rate, so including them in the stress test is a major development.
This is all the more true when you consider just how tough the stress test is. The idea is to see if you can handle rates at levels that are much higher than they are today. The reference rate is called the Bank of Canada conventional five-year fixed posted mortgage rate, and it's based on rates advertised by the Big Six banks. This rate now sits at 4.64 per cent, which compares to about 2.4 per cent for a nicely discounted five-year fixed rate in today's market.
A lot of housing bulls have based their argument on a view that interest rates are low and not about to rise in a serious, sustained way because the economy's too weak to stand it. But the more widely applicable stress test is like a back-door interest rate hike for some buyers.
"It's the same as if rates went up to 4.64 per cent overnight," Mr. Larock said. "There is a danger that government might have overtightened."
The existing stress test was just as tough. But it only affected a minority of buyers who, if they flunked the test, could move to a five-year fixed term and avoid it altogether. Now, that option is disappearing.
Only a minority of mortgages in Canada these days require mortgage insurance, which means a lot of buyers have down payments of 20 per cent of more. While it's not widely known, lenders are increasingly having these mortgages insured as well. Lenders are bearing the cost of the insurance, so it's basically an invisible process for the customer.
Starting Nov. 30, however, lenders will have to be more stringent in cases where they're insuring the mortgages of clients who have a down payment of 20 per cent or more. These customers will have to meet the same tough borrowing requirements as people with high-ratio mortgages (down payments less than 20 per cent). For example, the stress test will be used and the maximum amortization period will be 25 years.
Finally, the government is closing loopholes that foreign buyers use to avoid paying capital gains tax on homes in this country. Canadians do not have to pay tax on the gains if they sell their principal residence for more than they pay.
If all of these measures combined don't contain the housing market, there's always what the government calls "lender risk-sharing." If an insured mortgage defaults, lenders are 100 per cent covered. Ottawa wants to consult on the idea of lenders bearing at least some of the risk of a default, a change that would probably result in lenders being less aggressive with mortgage rate discounts.
Just as important as these measures themselves is the message they send to those who believe what's happening in our housing market today is normal or healthy. Ottawa's worried and it's taking action. Prices will not rise endlessly – base your financial decisions accordingly.
Rob Carrick