The Canadian government’s announcement that it is easing mortgage lending terms will have detrimental consequences for Canada’s real estate sector and may even make near-term rate cuts by the Bank of Canada less likely.
The new changes will drive more demand into a market with deep supply shortfalls and will worsen housing affordability over time. They are also likely to add to housing’s contributions to GDP growth, but may even worsen Canada’s productivity problem.
Be wary of these changes - there may be significant unintended consequences.
Make little mistake, this and other housing measure changes that are being announced are political and designed to address the federal government’s sagging appeal to younger Canadians on the assumption they won’t grasp the economics of the likely outcomes.
Here’s what Canadian Finance Minister Chrystia Freeland announced on Thursday:
· The mortgage amortization period for insured mortgages taken out by first time homebuyers buying newly built homes including multis was raised from 25 to 30 years effective August 1st this year. At least that part is out of the Spring housing market, but that was probably intended to support home sales into an election year instead of just now.
· The withdrawal limit for the Home Buyers plan is being raised from $35k to $60k effective on Budget Day next week. The HBP can be combined with the Tax-Free First Home Savings Account that allows contributions up to $8k per year to a lifetime limit of $40k.
· HBP participants between January 21st 2022 and December 31st 2025 are now allowed an extra three years to repay the amount to their RRSP for a total of five years.
· Lenders will now have to contact borrowers up to 24 months in advance of a renewal, imposing further regulatory costs.
· Temporary amortization extensions in the face of mortgage resets will now be possible to make permanent for all homeowners without fees or penalties. For example, a 25-year insured mortgage holder that temporarily extends to 35 years won’t have to renew back at the original 25 years and can now, depending on circumstances, make this extension permanent.
Some folks will stand to benefit from these changes but it’s vital to point out the following:
· The last thing that the housing market needs is more demand pressure on top of wildly excessive immigration, little supply, and a strong job market. This will complicate efforts to have supply catch up on the heels of the latest solid attempt at estimating the gigantic shortfall of housing that existed even before these recent measures. Ottawa continues to pursue an odd mixture of demand and supply measures that are conflicting with one another if the goal is to improve affordability over time.
· Added housing demand probably lessens prospects for rate cuts by the Bank of Canada and pushes them out. It would be unreasonable to throw rate cuts onto the housing market especially after Ottawa just threw jet fuel onto the market.
· The more money and resources that get fed to the housing beast, the less that is available for addressing the nation’s productivity problem. There is evidence that housing plays a role in the productivity problem at home and abroad. With these measures, even more of the share of the economy will go to short-term spending including consumption, housing and short-term government spending. That share is already running around its highest since the late 1980s and early 1990s when Canada was coming off of a major inflation and competitiveness problem.
· The conversion from temporary to permanent amortization lessens the impact of mortgage rate resets. That’s welcome to the affected folks who can lessen the near-term hit by taking longer to repay. It also means that the rate sensitivity of housing to BoC hikes has been dampened which could lessen the case for policy easing.
· The peak effects of these changes are designed to pump next Spring’s housing market in an election year more so than this Spring’s market. That’s why they delayed the 30-year extension to August 1st. The HBP changes are effective next Tuesday, but I suspect that few first timers have $60k kicking around in their RRSPs to use in the HBP right away. They’ll reallocate savings and income over the coming year into RRSPs to get the tax deduction and then face the 90 day waiting period before they can withdraw the amount. The RRSP season could be pulled forward and amplified by these changes at least until the withdrawals hit.
· The extended amortization period and raised HBP withdrawals limits will bring more cash into the market to drive house prices higher. There will be a first mover advantage on the changes. Second and subsequent round effects will see higher house prices that eat away at the benefits of the changes for subsequent entrants who are likely to witness worsened affordability. All you have to do is plug some numbers into your handy dandy mortgage or bond calculations and see what happens to the extra amount of house that can now be purchased as a result of the changes; applying leveraged likely means an extra six figures of housing can be purchased. The hot air and ink that Ottawa spends on the importance of improving affordability through debatable supply side measures is in marked contrast to policies that have induced wildly excessive immigration, very strong government spending, and now easier mortgage terms. It’s an unparalleled lack of policy coordination.
· Because of the requirement that RRSP contributions cannot be withdrawn under the Home Buyers’ Plan for 90-plus days, the effects of this change will occur in two or more stages. Those who already meet that criteria can start withdrawing the extra amount from next Tuesday onward. Anyone else will have to wait including people making fresh contributions that won’t be accessible until July.
· Extending amortizations to 30 years for new but not resale homes is a gift to builders who will capture some of the incidence effects through higher new home prices that through arbitrage may indirectly raise resale prices over time but by less and slowly. They can’t build enough homes fast enough due to skilled labour and materials shortages so prices and features will ration some of the demand. The flow through benefits will also go to folks building the homes and supplying materials.
· Only making 1st timers eligible will create unintended effects. It discriminates against other individuals already in the market who may be facing affordability pressures. It could also be gamed by, for instance, getting the first timer in a household to buy a home and not the one who already has title. Or parents can gift bigger RRSP contributions for the HBP eligibility.
· More people will be incentivized to make the minimum downpayment to get insured mortgages in order to secure the extra five-year amortization period. This will pivot demand more toward insured versus uninsured mortgages over time. Bear that in mind in terms of issuance volumes and market implications.
· Bigger withdrawal limits and longer repayment periods for Homebuyers’ Plan participants amount to a wealth transfer from the future. More retirement savings will flood into housing and raise potential challenges later.
· OSFI’s efforts to tighten mortgage finance markets over the years just suffered a setback. Ottawa continues to pursue totally uncoordinated housing policies by stimulating more demand amid severe housing shortages and driving risk higher.
Derek Holt is vice-president and head of capital markets economics for Scotiabank
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