Residential real estate relies on first-time buyers, like McDonalds relies on kids loving hamburgers. We need constant demand from young people to keep home prices on the incline.

So what happens when it gets harder for fledgling buyers to qualify for the same priced house? With other things equal, prices should drop to meet that new level of demand. But things are rarely equal.

As many know, two key mortgage rule changes are now affecting young buyers without 20% down:

• A cut in the maximum amortization to 25 years
• A cut in the maximum gross debt service ratio to 39%.

In the opinion of Genworth Canada CEO Brian Hurley (whose business is impacted by these rules):

“These are pretty dramatic changes, and I think they’re getting close to the tipping point. We see really qualified first-time home buyers with very high credit scores now not meeting the bar because they can’t afford a 25-year amortization. These people should be getting a home.”

RBC Global Asset Management economist Eric Lascelles told the Globe this week:

“I wonder if the drop from 30 to 25 years amortization might be regretted in a decade when interest rates have normalized…”

TD Economics said:

“There is little doubt that first-time home buyers – a market segment that has comprised as much as half of total Canadian sales in recent years – have been the most affected by the tighten­ing in mortgage insurance rules.”

The funny thing is, no one really knows how much real estate values will suffer by taking a slice of young buyers out of the equation. The only thing we know is that tighter mortgage rules are supposed to help long-term price stability.

Genworth estimates that the new mortgage rules will eliminate 15-20% of its high-ratio mortgage business. That’s notable because first-time buyers (mostly 25-34 year olds, says CIBC) account for the bulk of high-ratio mortgages.

If we use Genworth’s figures for a rough industry proxy, it’s not unreasonable to expect that at least 10% of first-time buyers could be shut out of the market by rule changes. (It’s good to excise fringe buyers, but not all of those 10% would be “risky” borrowers).

If you assume that up to half of purchases come from first-timers, then overall home demand could slide 5% or more—at least until home prices fall.

So, the mortgage rule effect may sting but it shouldn’t be catastrophic in and of itself. TD, for example, thinks the rules will knock down prices only 5%. Moreover, following rule changes in the past, sales have roared back within just months.

One big question is, how will stricter underwriting feed into other real estate risk factors? Those wildcards include:

• Interest rates — Rates are the #1 demand-side variable in economists’ home price models. A 1% rise chops the typical household’s buying power by ~9%. As we write this, rate hikes are still a ways off and TD says: “As long as interest rates remain at their current low levels, households still have a strong incentive to borrow and the overvaluation in the housing market will persist.”
• New Supply — Supply hasn’t overwhelmed demand since 2008, but inventories are slowly rising – especially in some condo markets.
• Employment — Job growth and wage gains help fuel home values. There is no obvious downturn on the horizon for either factor.
• Psychology — This is the most intriguing and unquantifiable factor of all. If/when we see three or four straight months of headlines reading “Home Prices Down X%!” buyers will get spooked and additional sellers will come out of the woodwork. How many, no one knows.

Mortgage rules are but one piece of the price puzzle. While Flaherty’s changes alone may not bring housing to its knees, tighter lending will certainly compound any weakness triggered by other wildcards.

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Rob McLister, CMT