Toronto real estate is in for a rough ride if new mortgage rules are passed. The Office of the Superintendent of Financial Institutions (OSFI) has proposed new draft guidelines. The mortgage industry is screaming this is the end of Toronto real estate if passed. We thought we would add some data to this discussion, specifically on stress testing rates. Turns out if it passes, a significant number of households in the city would be impacted. Whether this is good or bad is up for debate, but here are the numbers.
OSFI Stress Testing Conventional Mortgages
The new OSFI B-20 Guidelines would make quite a few changes, but today we’re just going to look at rate stress testing. The proposal currently includes a guideline that would see conventional mortgages tested 200 bps above contract rate. I know, banking jargon! Let’s break it down.
A conventional mortgage is one with a down payment higher than 20%. 200 bps is what people with a lot of letters after their name call 2%. Basically, any mortgage with a down payment higher than 20%, would require the borrower to prove they can pay the mortgage at a rate 2% higher. This would put conventional borrowers on the same page as insured borrowers. The reason the mortgage industry is not in love with this, is the likelihood of home prices dropping 20% or more is a lot slimmer than the 5% required for an insured mortgage.
Borrowing In Toronto Today
Today’s mortgage finance guidelines supports a lot of households that can borrow enough to buy a typical home. A typical home in Toronto is now $750,800 according to TREB. The lowest mortgage rate we could find without digging too hard is 2.89%. After a 20% downpayment, almost 49% of Census households had a median income that could carry the payments for a typical home under existing rules. The city’s expensive, but rates are low enough that they can at least carry the payments without too much trouble.
The above video visualizes the changes for conventional mortgage borrowing against median household income by Toronto Census tracts. The blue are Census tracts with a median income high enough to buy a typical home in Toronto, and the coral are tracts that can’t. The timelapse shows how this trend would change if stress tested at 200bps.
Stress Testing Toronto Households
Under the proposed guideline, borrowing power drops by just over 25%. While this won’t have a huge impact on most cities in the country, it will hit Toronto. Stress testing the rate of 2.89%, drops the number of households with median incomes high enough to buy a typical home to 38%. New rules would see a -22.44% change in the percent of households with high enough incomes. That’s a pretty big drop.
Now, don’t get me wrong – there’s two sides to these numbers. Ensuring that people can continue to the pay their mortgage at a higher rate is the responsible thing to do. However, there will be an impact on the number of people that could borrow. This either drops transaction volume significantly, as less people can qualify to borrow enough. Or this drops home prices, to continue the transaction volume. It’s hard to tell how people will respond to this, but this could be a contributor to the relative spike in inventory we’ve been seeing in Toronto.
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Thanks for this. This is absolute insanity to reduce buying power by this much.
There’s almost zero chance rates will rise 200bps over the 5 year term, and at renewal they could re-fi if they aren’t able to make the payments. This would make it easier to pay in the event rates rise, and they won’t lose their home.
Also, yes, I did say 200bps. Yes, I do have three letters at the end of my name. lol.
There’s a very good chance rates will rise 2% of the next 5 years. The hawkish BoC has said as much, and in fact has said that it needs to manage the profligacy of Canadian consumers. Plus, the US Fed is hawkish, has promised more hikes and their rates pull on ours.
There’s a good chance only by political pressure. Core CPI is nowhere near target, and has been below the median result over the past year.
If they raise interest rates at this point, they would be doing it solely to cool Toronto and Vancouver real estate, and not because they’re fulfilling their mandate as a central bank. If you think high Toronto and Vancouver real estate prices are a problem, wait until the country is introduced to deflation.
OSFI’s guidelines are the best way to address the borrowing issue in TO and Van, without taking the whole economy out IMO. It’s not about how likely it is that rates will be raised, but the allow the BoC to act on proper indicators, rather than social pressure from media.
Exactly. It’s not in the BoC’s mandate to tame the housing market, and this OSFI rule is a way smarter approach to it. The crying from the real estate industry I’ve seen in the media is often about how it will hurt first time buyers. Well… time will tell. If prices fall in the hottest two market then they’re actually further ahead. Unless well-heeled speculators pick up the slack.
I think the BOC has said over and over that interest rates are too blunt an instrument with which to control the RE prices.
Ideal consumers would stress test their own finances before committing to the biggest debt they will carry in their lifetime.
But rampant financial illiteracy and sales practices from mortgage brokers, lenders and realestate professionals is making people take on more risk than they should. When the said professionals stand to gain everything from pushing more debt on population than it can afford (if you can’t afford the debt with rate hikes, you shouldn’t be taking it) and lose nothing when people’s finances fall apart because of the debt they shouldn’t have taken on in the first place, government should step in and safeguard the population from its own inability.
Well said.
I would hope that most people understand supply and demand….with that in mind, if peoples borrowing power is decreased what is an eventual “must”…….anybody that has to sell or wants to sell has to price their homes according to what the new market “can” afford, and that’ll be less than it is now in only two places…….the same two places that have seen abnormal and disproportionate price increases, and that have been squeezing so many young people and families out of home ownership, and that have been taking the household debt to income level to frightening new heights…..so what is the problem again with getting this back in check?
At the start yes there will be those that don’t have to sell and those that don’t want to sell who will both hold back and for a very short time contract inventory….but as emotional as home buying is, with the ever increasing price downward adjustments, emotions will win over and the fear of losing more money will spur many listings in an over supply that will push prices further down…..for a time……just like they have been to high for a time….then the like always, supply and demand will hit another inflection point and head back up.
That’s the cycle folks…..if it’s not this there will be something else and you may not see it coming as clearly and as far out…..at least on this swing you could easily capitalize on your profits……know when to cash out….know when to buy in…..or hold and enjoy 🙂
Hi Kris. How soon after the stress test is implemented the prices will start coming down do you think? I mean immediately after, 1 month, 3 months or longer?
Willy,
Public sentiment is hard to pin point so specifically, however, sellers have 2 months to “cash-in” on buyers “soon to be decreased” ability to use low interest rate buying power so I don’t think it would be too much of a stretch to guesstimate that anyone who has been on the fence, whether to sell or to hold out for more – will sell. Those not needing to sell, and/or not looking to cash in will probably hold, and that’s fine, there’s plenty that can’t or don’t want to or never intended to hold. Once this supply is added over the next two months and the decrease in buying power follows on Jan.1, I once again don’t think it is too much of a stretch to guesstimate that prices will start to adjust to the new affordability levels which will be lower across almost all classes of buyers. In addition, keep in mind that builders have a lot of inventory to off-load and they are completely uninterested in holding onto these newly built units for any longer than they have to. So these new units will go to market and they will reflect what people can afford. If yesterday they could afford $750,000 soon they’ll be looking at $100,000 less…..if the builders are forced to adjust their prices, everyone else will have to as well, otherwise they will be over priced comparatively and their DOM will start to stretch…….have you ever seen the emotional response that sets in when someone can’t close the sale of a property they want to off load…..all rationale goes out the window when these emotional responses start kicking in….it’s been said that some buyers might turn to unconventional lenders to bypass the new rate rules, however, while this might be true for some people and to some extent, I would argue that if there’s an increase of listings and only price softening lies in the future, most people won’t be eager to do whatever they can only to take on a drowning level of dept on a property that is just one of many new listings all who are seeing their prices fall month over month.
Soon, the answer is soon Willy. But the real question, or rather the real answer everyone should be looking for is, for how long and how low will prices drop……the drop is coming, but the depth to which prices will fall is most important to anyone who sold at the high point and is looking to get back in at the low point and to repeat their success. The BOC can easily cut interest rates and give everyone their buying power back if the impact is too adverse, or any number of other adjustments can be made, however, these effects are only national, are controllable , and were announced……it’s always the internationally impacting uncontrollable factors that you don’t see coming that you have to worry about…..they can boost an economy or pull one down….I see a lot more downside storms brewing out there than I do to the upside.
All this said, I’m not a “real estate professional”, I don’t have 3 letters behind my name, and I’m no oracle.
Cheers.
Something else to consider…
Supply has been constrained for additional reasons and potential changes to B20 won’t create the ‘new market’ you speak of.
Here is an anecdote….if you sell a million dollar home you are inevitably paying 50k realty fees, some untold amount for breaking your mortgage early, legal fees, moving fees, stress etc. And guess what, if you buy another million dollar home, or sold to move up, the additional land transfer taxes for an equal value home is north of 30K in Toronto. Likely more if you’re attempting to move the family up. That decision to sell just cost the seller an extra 100k. In my case, I’m adding an extra level and not moving anywhere.
Why doesn’t OFSI just change the regulations which allow banks to give people making a median income of about $85k a $600k mortgage to buy a $750k house? Even at 2.89% that is absolutely insane, and is quite clearly the reason for the house price bubble.
This measure will do nothing to cool the market, just squeeze more of middle class out of market which will be readily filled by rich speculators and foreign investors who do not rely on mortgages as much
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