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.”

Comments

[Dale]

I think there are interesting arguments on both sides of the debate. The market doesn't seem unhealthy but it doesn't seem overly healthy either. One thing I do know is that Vancouver and Toronto prices should not dictate housing policy.

[Gritty]

I would never trust anything an economist says. They are no more realiable in their predictions than a Tarot Card reader.

[Paulo]

Hey Gritty,

That is an incredibly small minded opinion. I am not an economist, so I am not offended but consider your statement. Their business is based on speculation. Thats a tough business to be in, and for the most part they do a decent job.

Back to the article, the point on western provinces being overvalued I somewhat believe. Living in Calgary, it has been an interesting few months. In my community (started in 2003), since spring the median price of the homes sold have gone up 20%, and the number of new builds around us is astounding. Moreover, there is a potential of a land shortage next year due to the downturn.

This spring when everything was uncertain, the developers in Calgary didnt pursue new ventures. With the low rates, and prices that became "competitive and negotiable" the market took off. In the spring, the Calgary Real Estate Board projected a lean year regarding new builds, however that projected number has been increased by nearly 50% for the actual amount. It is a seriously curious market.

To complete this thought, I believe that this year housing prices have gained solely based on interest rates. However if Mr. Carney continues his plan to not change anything until Q3 2010, and with banks offering more competitive variable rate mortgages combined with a potential land shortage, prices in Calgary will not "fall into line" until 2011, and by then the economy is projected to be growing again....so say the "Tarot Card Readers" also known as Economists.

[T.O. Resident]

Carney should not raise rates solely to combat a housing bubble, as there are many other industries that would also be impacted.

However, the CMHC should be able to recognize that they are far exceeding even their own lofty targets (hence, the recent increase to CMHC's limit to $600B in insured mortgages).

If the CMHC were to impose 2 fairly minor changes, they could stabilize the market:

1) Increase the minimum down payment. I don't think that we'll ever get back to say 25%, but how about 10% or 15%? $30,000-$45,000 downpayment on a $300,000 house doesn't seem like a whole lot. If someone can't plan their finances well enough to save 10% or a downpayment, they probably don't need to be jumping into the housing market anyway.

2) Create a limit on the maximum loan amount. If someone is truly a first-time buyer entering the market (i.e. the type of purchaser that CMHC is meant for), then insuring a $500,000 or $1,000,000 loan seems rather ridiculous.

[Paulo]

T.O. resident, what you fail to realize with your first suggestion is the landlords then have more leverage to charge even more for their slums. In Calgary many people pay more for rent than some pay for a mortgage in a similar home, ie apartment vs condo..

Secondly, in Calgary the median price is in the 440k range I believe. That of course means there are places cheaper...however there are a lot of bona-fide crack heads in this city, and you get much lower than the median, and youre living with them.

There is something to be said about spending a bit more cash so your pregnant wife doesnt feel concerned about her safety when she goes to the local grocery store.

I dont like either of your options personally. When we built our house last year, the builders wouldnt even look at us without 10% down...so dont think I am coming from a place where I got a cash back mortgage etc.. Being self employed, I would have loved to put 35% down to get away from CMHC fees altogether...however that would have cost $125,129.xx Not possible.

[Gritty]

Paulo, my problem with economists is that they try to pass off their work as if it was a pure science, when in fact it is a psuedo science. If it were a pure science, you would find departments of economics in the Math Sciences faculty instead of the Social Science faculty. You and I may know that they are only speculating, but I am willing to bet that most Canadians take their words as fact. Until economists can accurately account for the role human emotions play in transactions, their predictions may as well be based on a coin flip.

[Radley77]

Some research I have done suggest that if the current sales to new listings ratio in Calgary of 70% holds for another year, the Calgary market will be looking at price appreciation exceeding 10% annually. This is obviously not sustainable and risks a sharper downturn.

I would think the right thing to do is tighten up mortgage regulations to exclude more risky buyers. This will allow rates to stay low to increase money supply, and promote the revitalization of Canadian economy, without the same downside risks of a housing downturn.

I think raising rates would have bad consequences to the GDP and employment picture. Keeping rates low allows for homeowners to rebuild their balance sheets and save more than normally. My thinking, is that the economy can heal better in a low rate environment, even if that cash is not going towards buying housing stock (and potentially creating a glut and unstable housing market).

[T.O. Resident]

To Paulo -- I think you proved my point with both of your statements:

1) if landlords and other investments property owners are the ones that the CMHC is insuring, we are all screwed.

The CMHC is supposed to be backing mortgages for first-time homebuyers, not trying to make landlords richer.

and

2) If it takes $500k-$600k principle on a 5%/35-yr mortgage for a first-time buyer to get into the market (when average household incomes are probably $100k in Calgary), that's a 5:1 to 6:1 price-to-income ratio. The US housing bubble popped at 4.7-to-1. The market clearly needs to correct before more and more people lose everything they've saved.

[Al]

housing 'bubble'?? Are these folk for real?!? Why on earth are people complaining because house prices have finally stopped going down and actually have rebounded a bit after a terrible couple of years. My apartment which I bought 2 years ago this very month is still worth about $45,000 less than I paid for it, so I'll be very happy if this gradual recovery continues so that I can at least get back to even on paper.
The short-sighted people who suggest that prices have been soaring or the market is red hot surely havent seen how far prices fell in the likes of Vancouver this past 2 years.
Lets hope for all our sakes that prices carry on moving up slowly and steadily, thats the best case scenario for all.
cheers

[Banker in Ivory tower]

wild numbers and predictions just confuses fact from fiction. The median price of homes in Calgary since the spring, have "not" gone up 20%. Actually, more like about 6%. Given the steep declines in Calgary home price since mid 2007, most people are welcoming the small uptick and confidence in the market.
To share Al's comments, There is no bubble at current. Stalling an economic recovery or making it near impossible or costly for new buyers to enter the housing market when general inflation is not a current concern makes no sense to me.

[Paulo]

To "Banker in Ivory tower"

If you decided to read the complete post then you would see I CLEARLY stated that the community I live in in within Calgary has seen the median price go up 20%.

Please read the complete post, rather than just skimming and making quick assumptions. When I see posts like that, one must assume that this "Banker in the Ivory tower" must live in a 1 story tower located somewhere in Nunavut.

[Banker in Ivory tower]

To Paulo, then maybe your comment belongs in your community newsletter rather than a national housing & mortgage forum. The going`s on within spitting distance to your house is of little relevance to Canada`s overall housing market.

In respect to economist and economic forecasts, you can't help but appreciate the public's cynicism towards Economist's. All the pro's got it wrong this past year and many people lost a lot of money banking on certain predictions. Prior to the correction, I can't count the number of customers that came into the banks and seriously expected their 3 bedroom shack with no garage to be worth a million dollars in a few years.

[Paulo]

To banker:

Again, you missed the point, go back and read the original post I made. You may, (but like will be unable) be able to connect what I am saying about my community, the calgary market the the statement on how the values are overvalued by 8%, as per the article. It is under point #3 in the original article.

READ THE ENTIRE POST BEFORE RESPONDING. For the love of god and all that is holy.

[Ash]

I second T.O. resident's comments regarding CMHC (Nov. 3). There should be a limit to the maximums or the lending ratio's... especially when a first time buyer is putting only 5% down. This will protect them more so than curb them. I am concerned about a friend of mine who is trying to over extend himself as I write this...

[Jonathan]

So average home prices are over double what an average home costs in the States. Our incomes are lower and this year we will surpass America on residential mortgage credit per capita (despite lower incomes). Our taxes are higher and are purchasing power is less. Almost all loans are 35/5 and many of the resets in three years from now will be 40/0.

You've got to be out to lunch if you don't think this isn't a bubble.

We lacked a catalyst like the US with subprime. But the market can't rise much more. Once all these buyers go into negative equity the market will tanks.

And if you're argument is that lenders have recourse, think again. Canada's housing market has tanked many times before. Florida also tanked, and they have recourse down there. Recourse will actually make the market worse, since it will trap people in their homes with unsustainable debt levels. The market will be flooded with bankruptcies rather than foreclosures. You would have to be naive to think that is a good thing.

[Dave]

Jonathan:

For a split second you sounded like you knew what you were talking about, until you said "Almost all loans are 35/5."

"Almost all" sounds like 90%, no?

Tell you what. Why don't you do some homework before you come on a mortgage site with fantasy statistics like that. If you want to humour everyone why don't you share your source for that percentage. We'll be waiting..............

Did you know the average mortgage in Canada is less than 1/2 the average home price? Bet you didn't.

People in Canada don't get mortgages without qualifying. Those qualifications are real...no NINJA mortgages here. Income doesn't have to rise that much for people to afford higher payments in 5 years. I think I read about 3%-3.5% annually.

Don't forget that over 5 years people will pay down their mortgages 10-15%. So prices could fall that much and people could still sell and pay off their mortgage if they had to.

Maybe the market doesn't rise much more, but that doesn't make it a bubble. Markets can and do go down in an orderly fashion. It's called (wait, brace yourself because this is a fancy concept) "a real estate cycle!"

The more guys like you pretend you know where housing prices are going, the less credibility you have.

DG

[bob]

Plus, in the US, there is greater incentive to default, since upon defaulting, you essentially don't have to pay it back.

In Canada, defaulting doesn't let you off the hook . . .

[Al]

to say the Canadian housing market is in a bubble solely because US house prices are CHEAP is utterly ridiculous! Perhaps the real answer is that US housing is ABSURDLY cheap. The fact that many Canadians (or people from many different countries in the world) could go down to the US and buy a nice house in CASH in many areas, to me seems far more about how unbelievably cheap house prices are in the US as opposed to Canada being 'in a bubble'.
Yes, there were reasons for the US housing market imploding but as the world recovers from this recession and as migration from China expands all round the world, even terrible housing markets like the US will begin to rise. In a few years I would suspect that people will look back and not believe how cheap house prices are in the US in 2009.....

[Andrew]

To DG

Can I get a source from when you said: "Did you know the average mortgage in Canada is less than 1/2 the average home price?"

If that is true, that makes a huge difference to the whole argument

[Bob Oblaw]

Al, I hate to break it to you, but you're making an emotional judgment because of your paper loss. Basically you bought at or near the peak, and you're hoping to see prices appreciate so you can get out of your negative equity situation, and "thats [sic] the best case scenario for all."

I'm sorry, but it really isn't. It might be the best case scenario for you, but it's hardly the best case scenario for most of us.