Getting Approved Before Prices Fall

falling-home-values For the last 4-5 months or more, newspapers have been chock full of headlines like: Are We in a Housing Bubble? 

That’s got many expecting a drop in home prices.

When home prices do fall, it makes it tougher for certain people to qualify for a mortgage—especially for refinances. When prices start dropping, appraisals come in lower, insurer valuation systems become more conservative, and lenders tighten up in general.

Vince Gaetano, a broker with Monster Mortgage, tells the Financial Post that people are already trying to get approved “before there is a correction in the real estate market.”

On that note, here are three scenarios where a small drop in home prices can matter:

  • A borrower who wants a line of credit (LOC):
    If the homeowner has 20-25% equity, it may pay to act sooner than later.  That’s because LOCs require a minimum of 20% equity. If your loan-to-value is 75-80%, for example, it only takes a small drop in home values to push you above 80% LTV and keep you from getting approved.
  • A borrower wanting to refinance to 90% LTV:
    90% is the maximum loan-to-value for a refinance. Suppose you’re at 85% LTV now and want to roll some high-interest debt into your mortgage. In this case, even a 3% price drop could eat up most of your equity. That could make a refinance not as worthwhile—if at all.
  • A borrower looking to refinance to 80% LTV:
    80% is the maximum loan-to-value for uninsured financing (assuming you want the best rates). If your current LTV is in the high 70% range, a small price drop could push you over 80% loan-to-value—requiring that you pay default insurance to get the best rates. Exceptions apply, however, so speak with your mortgage advisor.

Long story short, if you’re in the market to refinance and you think home prices are headed south, it may pay to get your appraisal and approval soon.

  1. Any idea where i can see how each region or province is projected to be impacted by this.
    Basically how over-priced is the housing market in each area. Just curious. Thanks in advance

  2. There’s no easy answer to that. Nobody can say for sure that prices will even go down. Australia has been holding up remarkably well and they look bubblier than Canada with much higher interest rates.
    While I believe that prices will go down, I’ve been wrong on the timing — mostly because (IMO) of gov’t intervention (0/40 loans then easing qualification rules followed by a crash in interest rates due to financial crisis).
    People have been talking about the Canadian housing bubble since around 2005. It really started to get loud around 2007 and 2008. But we’re still going strong.
    It would be very interesting to see all of the CMHC program changes since 2000 on a timeline (eg, 10% down, 5% down, 30 year, 35 year, 40 year, 0 down, low-doc (self-employed) loans etc … Then back to 5/35 down, variable-fixed quals and 2% interest rates). My guess is that this bubble would have popped long ago if not for government intervention… In fact, I’d say it never would have formed without it.
    Only time will tell.
    But to your original question, if you want anecdotal… Vancouver is the bubbliest and credible people are calling for anywhere from a 25-50% drop. Toronto is second, with credible people calling for a 15-30% drop, and Calgary and Edmonton have already lost some, but due to lose more… I don’t hear as much about those two (cue the angry Albertans), but maybe someone with more exposure to western press could chime in.
    Probably more than anything else, it depends on how CMHC reacts to falling prices… They’re really the biggest wildcard in all of this.
    In short, if it pops, I’d say expect everyone to fall back to roughly 2005 prices, possibly beyond.

  3. I don’t think I’ve heard or read anything dumber than this since John Mayer told everyone he was black.
    No matter what, interest rates are going up. Maybe not for the next 2-3 or even 10 years, but mark my words – I, as an investor refuse to commit capital to a venture that bears no return – I would rather spend it on myself.
    100% loans to borrowers for real estate purchases are risky – the only things keeping rates low at the moment are the abysmal private sector growth and government intervention (i.e. the CMHC). When the Fed runs out of bullets and the market begins to fight back, interest rates are going up.
    An increase to 10% in interest rates will roughly double your mortgage payment over what most high LTV borrowers are paying today. When your huge, HELOC bloated mortgage term ends in 5 years or less, I as a lender, am going to take your house because you are holding the bag on a mortgage that you can only afford at emergency rates and fake bubble-driven equity.
    Have fun cooking Kraft Dinner in those stainless steel appliances and eating it off of granite countertops, just be sure to keep the place clean for when I need to sell it.

  4. Ummm, Ridiculous, were you replying to my comment? If so I think we’re on the same page. And if you read between the lines, I think the author pretty much agrees with you too.

  5. Hey Ridiculous,
    Read your own comment. Now you’ve just read something dumber.
    “No matter what, interest rates are going up. Maybe not for the next 2-3 or even 10 years.” isn’t exactly the most intelligent thing I’ve ever heard or read. I would have been more impressed if you predicted the sun would rise in the morning. Of course rates will increase in 10 years.
    By the way, no one is lending to 100% anymore, at least not to the extent it poses any serious risk. Where did you get that “fact”?
    One more correction. Your suggestion of 10% interest rates is based on what? The only way rates would climb that high is with hyperinflation. If you think that will happen then you probably have no comprehension of monetary policy. You must be from Brazil or something?

  6. Phil, take it easy.
    First, predicting the timing of a bursting bubble is a fool’s game. Tons of people predicted the US housing bust but got the timing wrong.
    Second, there are more 100% mortgages than meet the eye. Even if you put down 25K from your own RRSP (or 50K), it still has to be paid back on time even if it is without interest. And if you don’t put interest in (in the form of additional RRSP payments), your retirement is going to be an uphill battle.
    Then if you don’t pay your RRSP back on time, it’s taxed at the highest marginal rate — a stinging penalty for most.
    Cashflow is the name of the game, and having a bank and CRA after you at the same time when you’ve lost a job isn’t something many people can manage. Add to that the costs of liquidating your house under distress and you’ve got trouble.
    Debt is debt and owing your own RRSP is no different.
    Beyond that, 5-7% cash back from the bank… Loans (I mean “GIFTS” from family) … And yes, the old 0/40 guys still kicking around. There are lots of 0%ers abound.
    Lastly…10% mortgage rates does not hyperinflation make. Ten percent, while seemingly impossible right now, would have been a gift from God 20 years ago.

  7. You said, “When home prices do fall, it makes it tougher for certain people to qualify for a mortgage—especially for refinances. When prices start dropping, appraisals come in lower, insurer valuation systems become more conservative, and lenders tighten up in general.”
    A lot of people are under the impression that banks will ALWAYS work with borrowers to work something out. What sort of drop do you envision would create situations where people couldn’t renew the mortgages on their homes?

  8. This article is not talking about renewing, it’s talking about pulling equity out as cash before prices fall.

  9. “A lot of people are under the impression that banks will ALWAYS work with borrowers to work something out.”
    The only thing close to being guaranteed by a bank is that they will make money, whether you do or not. If lending money to a homeowner is expected to reduce bank earnings when compared to the best alternative foregone (i.e. seizing your house and selling it on the open market) then they will not lend you anything.
    Like I said – this article is one of the dumbest things I have ever read. Go ahead – renovate your house on cheap credit collateralized with equity built up during a bubble. Just don’t go crying to the Fed or whine about how “it’s not fair” when the bank takes away your house because the value of the collateral pledged for the mortgage and HELOC (i.e. your house) has returned to sane levels and you’re now underwater on your mortgage while interest rates are climbing.

  10. Good luck to you, there are more houses/condos/apartments for sell/buy than people that need it.
    Just small reminder your property tax will go UP-UP-UP and you will not have no one to rent to. For me that looks realy bad investment strategy.
    Take care

  11. I’m not sure about this one, but I don’t think they take your house if the value drops. I doubt they care as long as you make your payments.
    … Now *renewing* a mortgage when you’re underwater it a mighty fine way of ensuring that you pay a stupid high rate upon renewal ( after all, you can’t leave the bank you’re with). But I don’t think they’ll take your house because your owe more than you own.
    Does someone on this forum know for sure?

  12. I am not a banker and don’t have a mortgage at the moment, so who knows what’s in some of those contracts these days. If you’re mid-term, the bank can’t do anything that is not stipulated in the mortgage contract, so que sera sera, I suppose.
    When it comes time to renew however,(which is at most 5 years from now), the bank has no obligation to lend you anything (see link below)
    Would you lend someone 120% of what the fair market value of their property is @ 2.25%? Not bloody likely. You are right Err – being underwater is a great way to end up with a bloated rate or get foreclosed upon at renewal.
    Renovating using bubble equity only increases the probability of getting into trouble down the road. Minimum equity via HELOC = maximum risk profile at renewal= maximum likelihood of a high rate or foreclosure at renewal once values return to sane levels.
    The existence of a bubble is not even debateable at this point – if house price > 150x rent, the market is overvalued. There is no tangible benefit to owning if you can rent for less. The city you live in is no different if you rent versus own a property in it.
    Buying because you think it will be worth more next year only works until it doesn’t.
    Pay off your mortgages people and stop pretending you’re rich when you aren’t. Tough times are ahead.

  13. I’m not a banker either, so this is just speculation… (It would be interesting to hear from one of the pros on this site who seem awfully quiet these days.)
    CMHC insures the mortgage, so there’s very little incentive for your existing lender not to renew on that juicy, high-ratio, 35 year, government guaranteed goodness. I would expect high ratio renewals to keep happening simply because they’re profitable (and chock full of moral hazard).
    Folks who are underwater won’t be able to sell their homes. They simply won’t have the cash on hand to make up the shortfall, pay the realtor, taxes etc. That means a (much) smaller pool of potential buyers which translates into lower prices.
    I doubt that moving your underwater mortgage between lenders is an easy thing to do. So even with CMHC, the rate is almost certain to be jacked because your current lender knows you can’t leave.
    With interest rates near zero and average Canadian debt at record highs, there’s very little wiggle room left…
    April 19th was the first turning point. It’ll be interesting to see what fall 2010 has in store.

  14. The last thing banks want to do to a good customer is foreclose. It makes no economic sense for the bank. That is why they will always renew you if you make all your payments on time, regardless of whether you have negative equity.

  15. Rediculous
    Why would a bank seize a perfectly good customer’s house when they have negative equity? That is a no win situation for the bank.
    To your second point, I don’t think I understand your issue with what Rob and Melanie are saying. It seems they are simply advising that if you are planning to refinance anyway, you may want to act before home values fall.
    P.S. There are many other reasons to refinance besides renovating a house. Many people refinance to invest or consolidate high interest debt. Both of those are very valid strategies that might not be accessible to certain people if housing prices fall.

  16. Hi Jim,
    You are correct in that this article does not advocate refinancing where not appropriate. We were simply bringing it to people’s attention that falling home prices will make it harder for certain refinancers to get good terms. For those people, it may very well make sense to refinance sooner than later.

  17. Hi Err,
    A lender can always choose to not renew someone or call in a line of credit. In practice (to repeat another comment in this thread), lenders typically don’t do this unless the borrower has defaulted on a loan condition.
    Your second point is definitely applicable where a borrower cannot switch lenders due to insufficient equity. In other words, some people will undoubtedly get stuck with their existing lender’s renewal rates if home prices fall. But you can still try to bluff the lender’s retention department by using lower quotes that you’ve found elsewhere as leverage. Lenders typically don’t sent appraisers out for renewals.

  18. Hi RW,
    Lenders don’t want overvalued assets on their balance sheets. For example, if a borrower’s home is worth $200,000 but their mortagage balance is $220,000, the lender cannot foreclose and become whole. In a negative equity situation, lenders are better off letting a good customer keep paying down their principal as normal.

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