Thanks to our friends at B2B Bank for their economic outlook report.
With the new mortgage regulations in place, now is a good time to discuss the state of the Canadian housing market. Previous tightening in mortgage rules, including the reduction in the maximum amortization period from 30 to 25 years in 2012, have not been enough to temper buyers’ appetite for risk, especially in expensive Toronto and Vancouver markets.
The substantial drop in interest rates likely offset the effect of stricter regulations in recent years, allowing many households to become homeowners. The current context is quite different. The likelihood that the very low mortgage rates will drop further is much lower than it has been in the past. Rising interest rates on the bond markets in the wake of both Brexit and the American election outcome and stricter rules for Canadian lenders suggest that interest rates will rise, though more slowly than in the past.
Therefore, the federal government’s new measure for ensuring a buyer’s borrowing capacity at higher interest rates will likely have a lasting effect. The bar for becoming a homeowner was raised in mid-October, with the ultimate objective of reducing default risk in the event of a negative economic shock. All potential buyers with a down payment of less than 20% must now pass a stress test based on the posted mortgage rate (currently 4.64%) to qualify for a mortgage and to determine the maximum borrowed amount. This stress test even applies to those choosing a fixed-rate, 5-year term, the preferred product of two-thirds of mortgage holders. By making access to home ownership more difficult, borrowers, especially first-time buyers, will have to adapt: by saving longer before buying a property, looking for a similar property in a less expensive neighbourhood or buying a smaller house.
Testing a buyer’s ability to handle higher interest rates for all insured mortgages will have a relatively larger impact in the competitive markets of Toronto and Vancouver, where buyers have been borrowing more relative to their financial capacity in recent years. Thus, Canadians looking to become homeowners soon must reassess their strategy, which should slow the fast-paced market over the next few months.
In Toronto in particular, Ottawa’s new stress test requirement will help cool the overheated market which has been driven by vigorous job creation and the lack of land supply. These conditions have made Toronto the only place in the country where prices are rising sharply. The new stress test combined with a shortage of affordable housing in Toronto may help strengthen the current trend of buyers looking to neighbouring cities such as Hamilton and Barrie. This being said, the federal government’s higher immigration objective for 2017 will benefit housing demand in Toronto and surrounding areas and will likely minimize the impact of the new stress test. Also, the Ontario government announced that first-time buyers will benefit from an enhanced rebate on land transfer tax starting in January 2017.
In Vancouver, the stress test will prolong the housing cool off that began last spring. The federal government’s announcement comes at a time when some potential buyers were already sidelined by uncertainty created by the new 15% tax on residential housing for foreign buyers. Since the introduction of this tax on August 2nd, foreign buyers have been involved in only 1.3% of resale activity in the Greater Vancouver area, as compared to 13% in June and July. While the virtual disappearance of speculative activity will likely slow the high-end market, buyers seem more reluctant to purchase across all categories of housing, including entry-level condominiums. This slight loss of confidence contributed to both a drop in sales and in price stagnation this fall. This slow down should be short lived considering the return of many British Columbians from Alberta and new well-paid jobs, both of which will increase demand for housing. Construction of smaller, more affordable condos should also help maintain a healthy level of activity.
In Montreal, the new stress test will only modestly affect a buyer’s borrowing capacity due to the city’s relatively affordable market. For example, the price of a single-detached house in Montreal is lower than the price of a condo in both Vancouver and Toronto. However, the test will affect a larger percentage of the population in Montreal and throughout Quebec compared to the rest of the country, as the Quebec housing market is more dependent on first-time buyers (39% of Quebecers rent, as compared to approximately 30% in Ontario and British Columbia). Ultimately, this new requirement will not have a significant effect. The housing market in Montreal, already on solid ground, should remain balanced: moderate job creation, less speculative activity and fewer high-risk first-time buyers should minimize the impact of the new federal measures. Ideally, a slowdown in new construction should continue to help absorb the number of new, unsold condos, which is slightly above historical norms.
Finally, in Alberta, the slightly more challenging access to home ownership caused by the latest tightening in mortgage rules will delay the rebound in housing market activity, which remains relatively slow. Stabilization in employment since last summer is a sign that the worst is behind us. The significant downturn in construction by developers is also helping to stabilize housing prices and preventing the market to fall into an oversupply situation. The situation, however, remains far from perfect. Albertans continue to leave the province in search of work, which may result in fewer potential buyers and less demand for mortgages for some time.
Author: Sébastien Lavoie | Chief Economist Laurentian Bank