The Good News About Cheap Money

Yesterday we listed the side effects of the current low-rate environment—namely, that current rate and finance policies are over-stimulating Canada’s housing market.

Now we’ll give equal time to the other side of the story.  That is, that the market’s current level of liquidity is a net positive.

To that end, here are 13 reasons why low rates and current lending guidelines might not be a disaster in the making...

1. Most economists would contend that low rates are keeping Canada’s economy alive, and that employment would plummet without them. The real estate market may no longer need low rates, but the rest of the economy absolutely does.
2. Home prices haven’t skyrocketed as much as some might think. CREA says prices are up 11%, but they also say that figure is “skewed” by Canada’s “priciest markets.” Teranet says home prices are actually down 3.43% YOY.
3. The IMF says Canadian home prices presently reflect long-term fundamentals and are “close to equilibrium.” (Although western provinces are 8% overvalued they say.)
4. Canadian lending standards are still rock solid. All the “risky mortgage” headlines making the rounds lately don’t tell the whole story. The fact is, lenders refuse to take undue risk. We’re not mainstream journalists writing from the outside. We’re inside, and we see the deals lenders are approving and declining. The people getting 5/35 mortgages (5% down / 35-year amortizations) are getting them because they’re well qualified. It’s that simple. As a side note: The frequency of lender “exceptions” (lenders overlooking guidelines) are nowhere near where they were pre-August 2007.
5. Subprime mortgages still account for only 5% of mortgages in Canada versus the 20% seen in the US before the crash. (This refers to the standard definition of subprime, not the media definition.)
6. Higher prices and rising rates will encourage sellers to enter the market, thus creating equilibrium and acting as a natural counterbalance to excess. Since thousands of Canadians bought this year instead of next, demand could fall in 2010, which would also temper overvaluations.
7. The Finance department and Bank of Canada are watching the market daily. They are well aware of recent press, and well aware of key housing valuation metrics. The last thing they want is blood on their hands if real estate gets out of control.
8. Canadian mortgage arrears are well in check. They’re still just 0.40%. (The range since 1990 has been 0.18% to 0.65%.)
9. 2/3 of new mortgages this year have been refinances—the bulk of which benefit the borrower and consist of either: a) replacing high interest debt with low interest mortgages; or, b) borrowing to renovate or invest.
10. Speculative activity has been modest. Only 5% of home purchases have been from investors, versus 40% in the U.S. (before the housing crash).
11. People can’t walk away from mortgages in Canada. For most, lender judgements will follow them wherever they go. That is a strong incentive to pay, and a strong incentive to not get in over your head.
12. The mortgage payment-to-income ratio in Canada is currently just 30%—about where it was in 2002. It was 38% before the peak in 2007. (Source: CMHC)
13. The typical economist seems to project a ~2.5% interest rate increase in the next five years. Let’s suppose a doomsday scenario unfolds and rates rise 4% (to say, 8% on a 5-year fixed). If the average household income is $61,800 today, and the mortgage is $250,000, that would necessitate a $10,400 pre-tax income jump in five years to pay the extra debt service.  That’s just over 3% annual wage growth—not an unreasonable earnings growth assumption.

None of this is to say that home prices are not higher than they should be in some markets.  Then again, it’s not our game to speculate on home prices. Suffice it to say that there are two sides to the debate on lending policy and low interest rates.

Yesterday’s story paints an unhealthy picture of Canada’s housing market. Today’s story takes the opposite tack.

In sum, if someone were to ask…

• Should the Bank of Canada raise rates to curb lending and housing prices?  (Carney said he wouldn’t.) 
• Should the Finance Department enact new mortgage limits? (be them amortization, credit, down payment, etc.)

Based on the facts we’ve seen, an objective observer would  have to answer:  “Not if the balance of evidence must be conclusive.”