Baby, we got a bubble!?

[CN Tower]

Lamb's comments are predictably self-serving. The problem traces back to personal accountability and who is left holding the bag.

At the core, the CMHC/Federal Government/taxpayers are on the hook for the overwhelming majority of new mortgages written today. The chartered banks are basically indifferent to the outcome although their preference is a stable market I'm sure as they earn huge amounts off the issuance of mortgage debt.

It's quite obvious that the Conservatives see a slowing and trending down housing market. They don't want all the negative political fallout from a large CMHC loss. It could easily run well into the $10s of billions. Why not? I think CHMC guarantees $800b in loans so a 10% loan loss is not inconceivable.

Personally, I take a more hands off, laissez-faire view of the housing market. Let buyers blow themselves up with debt if accountable lenders are willing to take the risk. The problem is that it's not the banks on the hook, it's the taxpayers, ultimately. If banks were underwriting honestly they wouldn't lend as much capital or as cheap. But for whatever reason Canadians feel that home ownership is some sort of constitutional right.

Essentially I am making a long winded case against the CMHC. It serves no purpose ultimately in my opinion and causes the problems seen in the US housing market by artificially stimulating the housing market. No politician has to guts to unwind this mess but eventually someone will have to do it.

 

[interested]

^^^
However it is exactly the banks who are reportedly telling Flaherty to raise the limits.

I believe the problem from the banks (who are admittedly self serving entities as well) is they were and probably still lose business to smaller brokerage operations who will take more risk and hence scoop away business from them. By raising the requirements, they force everyone to play on "their" playing field as it were, where they have a great advantage.

As far as CMHC, the reality CN Tower is that it is here to stay. And I think it is a reasonable thing to have in existence if one believes that home ownership should be available to all. That said, I think young people are being sold a bill of goods that they should have everything at the age of 24, downtown living in a condo that they own. My parents tell me on how they didn't sleep at night having a conventional mortgage and there were the days of mortgage burning ceremonies. Yet alot of people think nothing of carrying 95% debt on a property so long as they service it today at the lowest interest rates/mortgage rates in 50 years. My point is that alot of people who should not be owners are being encouraged to own both as societally acceptable, good politics, and yes by a real estate/development industry slickly marketing to them a lifestyle. After all, who wouldn't want the live the millionaire's life style purported that is "affordable" on $35000 of income a year???

And our young people are only exhibiting behaviour they have learned I am sad to say from my generation of Baby Boomers. "It is not what you can afford to buy but what you can afford to carry". God help you should you lose your job or get sick.

However, as you point out, CMHC really should be only available to first time buyers to help insure when they have less of a downpayment but really strong incomes that clearly indicate that they have the "earning power" if not the down payment yet. It should not be available in my view to investment purchasers and putting the burden to tax payers.

And yes, the Banks should keep mortgages on their books and I assure you they will be cautious. It was the politicians who encouraged the banks to take on the risks. Witness Mr. Flaherty introducint the 40 year 5% down mortgage and even zero percent allowable until he saw the blowup in the US and realized what folly this is. Now he takes credit for being "vigilant".

Long winded response CN Tower. I think however we are generally on the same page.

 

[Eug]

In 2009 for an investing property I was asked for 30 to 35% down plus appraisal so I think Eug means is there a real change from rule tightening. It seemed some of the lenders might have always asked for 30 to 35%. So does anyone remember how long the loosen period existed ie Zero down or 5% down on investing properties? Or does it still exist today, so it really is an inconsistency problem?

Yes, I was just saying that some lenders were rather strict for luxury homes even long before for the 2008 downturn. For a high dollar home (like the one's interested's wife might deal with), it was not uncommon for a lender to ask for a 30% downpayment or even more. If you "only" had 20%, they'd ask you to pay for CHMC insurance on top of that. This is in stark contrast for an average home. If you spend $400000-750000 on a home in Toronto, if your credit rating is OK and you have a regular source of income, then just about nobody will ask you for CHMC insurance if you can come up with a 20% downpayment.

To put it another way:
If you buy a $750000 house, then your downpayment would need to be $150000 to avoid CMHC insurance.
If you buy a $2000000 house, then your downpayment might need to be $600000-700000 to avoid CHMC insurance.

That's quite the difference. 2.67x the house price, but 4X - 4.67X the downpayment required.
And who knows what a lender would want if the house were $10 million... 65% downpayment? I have no idea.

And this isn't even for rentals. This is for primary homes. I'd be shocked if they weren't more strict for rentals.

 

[cdr108]

i have to agree with CNTower and interested.

FWIK maintenance fees are comprised of 85-90% current costs (utilities, labour, property management fee) + 10-15% reserve for future costs, so to currently only use 50% of maintenance fees is folly.
in addition, pre-construction maintenance fees are ALWAYS understated because developers like to market their development as more affordable that resale, when in reality after the 2nd year when the developer is off the hook for shortfalls, the fees go up dramatically ( i know where people's fees went up 25-50% from the initial developer's quote).

it may affect 1st-time buyers and investors more, but if you can't tolerate an additional $150/m (based on 50% of the typical maintenance fee for a 500-600 SF unit the aforementioned buyer would purchase) in the GDS/TDS ratios, then one really has no business in buying one of the largest purchases in one's life.

frankly, 1st-time buyers are more ignorant of the realities of owning and believe the spiel of developers/RE agents thinking price appreciation is a given, and that paying rent is 'throwing money away'.
at current prices, for the same property, rent costs about 1/2 cost of ownership when mortgage, maintenance fees, property taxes, utilities, etc are all calculated.

if the gov't was serious about limiting a RE bubble in Canada, they would also put limits on foreign ownership.
several Asian countries recently further increase DP requirements because of concerns of more QE2 money flooding their already inflated property markets.

CMHC should raise the minimum DP requirements to either 10% or lower the amortization to a max of 30 years.
it's better to deflate a bubble gradually than have it inflate bigger then burst like our neighbours to the south.

 

[Eug]

Before the change to 5% and 35 years, I said it should be 7.5% and 35 years. I wouldn't argue with 7.5% and 30 years though.

Jumping up to 10% for the downpayment would be tougher. On a $400000 home, that would increase the downpayment from $20000 to $40000. At 7.5%, it'd be $30000.

How about something like this?

1. Increase downpayment to 7.5%.
2. Increase proportion of condo fees used in the calculation to 75%.
3. Keep max amortization at 35 years.

Or else:

1. Increase downpayment to 6.5%.
2. Increase proportion of condo fees used in the calculation to 75%.
3. Decrease max amortization to 30 years.

 

[Klieg]

What will happen to people who already have binding agreements to purchase pre-construction condos and were pre-qualified for mortgages using the existing standards? If the government's changes are drastic enough, there may be a lot of first time buyers who won't be able to close anymore when the time comes.

Perhaps some sort of gradual phasing-in of the changes would be in order here, as there was with the introduction of the HST.

 

[interested]

^^^
Eug is absolutely correct. I confirmed with my wife. The rule is 80% on the first Million and 60% on anything above.
So they would only lend for eg. 70% on a 2 million dollar home exactly as Eug said in his example or require $600,000 equity minimum.

 

[interested]

What will happen to people who already have binding agreements to purchase pre-construction condos and were pre-qualified for mortgages using the existing standards? If the government's changes are drastic enough, there may be a lot of first time buyers who won't be able to close anymore when the time comes.

Perhaps some sort of gradual phasing-in of the changes would be in order here, as there was with the introduction of the HST.

That is what would happen. They would grand father existing agreements just like they grandfathered all agreements. It would be politically impossible to do and they would not likely apply a retroactive rule. Even if the government did, there would be so much fuss from developers, realtors, constituents that they would back down. But trust government if they do do this to get it wrong in the early phases.

 

[interested]

Before the change to 5% and 35 years, I said it should be 7.5% and 35 years. I wouldn't argue with 7.5% and 30 years though.

Jumping up to 10% for the downpayment would be tougher. On a $400000 home, that would increase the downpayment from $20000 to $40000. At 7.5%, it'd be $30000.

How about something like this?

1. Increase downpayment to 7.5%.
2. Increase proportion of condo fees used in the calculation to 75%.
3. Keep max amortization at 35 years.

Or else:

1. Increase downpayment to 6.5%.
2. Increase proportion of condo fees used in the calculation to 75%.
3. Decrease max amortization to 30 years.

Eug; we could argue about what would be reasonable. Certainly amassing more of a down payment is more onerous that decreasing the amortization period. That said, full condo fees must be used as this is frankly a no brainer.

However, I go back to my original point. If you can't manage 10% down and meet your condo fees with even a 25 year mortgage or OK let's say 30 years, maybe you should not be buying "just yet". We have grown in the Western World into a society who wants everything now and wish to pay with it with credit, borrowing from our future for present enjoyment. While for major purchases like a house this may be reasonable, having people own 1/20th of the equity and be a slave to a mortgage their whole working life is frankly not sound fiscal policy and only has worked to now because of rising prices of houses, largely due to falling 5-10 year bond rates. Well, falling 5-10 year bond rates are a thing of the past. We are at 50 year historic lows. Everywhere you read interest rates are going up and that is going to make housing less affordable. So rather than price appreciation, we may well be looking at stagnant or decreasing prices. And in this environment, it makes no sense to burden or allow first time buyers to take on that risk. Not only if there is a downturn will the first time buyers lose their homes, but it has the potential to snowball and engulf responsible purchasers who had 20 or 25% equity and as more people default, there will be more reposessions. As well, why should responsible taxpayers be on the hook for lack of forethought or appreciation of risk of those who want to have everything on credit today.

I do not mean to harsh but I do not believe for a minute we are doing anyone any good by saddling them with huge debts early on. Society at times has to play a responsible role because business and industry left to itself will focus on the short term gain and not worry about the societal cost afterwards.

I am a professional and my wife has a good career and yet we purchased our first home when I was around 30 years of age and with incomes between my wife and I that would be the equivalent of about 1/2 the value of the home. I appreciate not everyone will be as fortunate as we were to have high paying jobs with alot of upward potential but people buying homes at 5x and more of their present income is simply not reasonable from my point of view.

 

[Eug]

5X is pushing it, but 4.5X is probably OK.

 

[interested]

^^^ Historical I believe is 3 to 3.5x. Even 4.5 x is alot Eug.

I guess where we differ is that I hate to see people who are marginal being placed at risk. I believe as a society we have an obligation to save the more vulnerable from themselves.

We had a brief scare at the end of 2008 to 2009 of what can happen.

I remember 1989. Condos went from$250,000 down to $150,000-$200,000 over the next 3 years to 1992 and then essentially stabilized over the next 4 years before starting a climb again in 1996. Needless to say. Alot of equity to wipe out and alot of people who had to refinance in that time period would not qualify.

It happened before, and in a rising interest rate environment, the slightest shock could be enough to trigger a major correction.

So I think 4.5x is frankly too much. But more important. Down payments need to be much more. Even 10% I would say should be the absolute minimum downpayment except in exceptional circumstances. Full condo fees included. Maximum 25 but OK I would agree to 30 years for mortgage terms. 35 and 40 years are new phenomenons to Canada and frankly were a very bad idea.

If something should happen and rates do go up and/or house prises fall, there will be alot of marginal people wishing they had heeded these suggestions unfortunately.

 

[Eug]

^^^
Eug is absolutely correct. I confirmed with my wife. The rule is 80% on the first Million and 60% on anything above.
So they would only lend for eg. 70% on a 2 million dollar home exactly as Eug said in his example or require $600,000 equity minimum.

BTW, that also applies to HELOCs.

^^^ Historical I believe is 3 to 3.5x. Even 4.5 x is alot Eug.

I guess where we differ is that I hate to see people who are marginal being placed at risk. I believe as a society we have an obligation to save the more vulnerable from themselves.

We had a brief scare at the end of 2008 to 2009 of what can happen.

I remember 1989. Condos went from$250,000 down to $150,000-$200,000 over the next 3 years to 1992 and then essentially stabilized over the next 4 years before starting a climb again in 1996. Needless to say. Alot of equity to wipe out and alot of people who had to refinance in that time period would not qualify.

It happened before, and in a rising interest rate environment, the slightest shock could be enough to trigger a major correction.

So I think 4.5x is frankly too much. But more important. Down payments need to be much more. Even 10% I would say should be the absolute minimum downpayment except in exceptional circumstances. Full condo fees included. Maximum 25 but OK I would agree to 30 years for mortgage terms. 35 and 40 years are new phenomenons to Canada and frankly were a very bad idea.

If something should happen and rates do go up and/or house prises fall, there will be alot of marginal people wishing they had heeded these suggestions unfortunately.

4.5X is fine for disciplined homeowners. Perhaps not so fine for others.

Note that 4.5X factors in much higher interest rates than where they are right now.

As for 10% downpayment and 100% condo fees, I think that's reasonable, but not entirely necessary. As I said, 7.5% downpayment and 75% condo fees is a reasonable compromise.

 

[interested]

Eug,

Let's agree to disagree.

I can see a 7.5% downpayment as a first step towards increasing to 10% in the next few years.

I cannot agree with the 75% condo fee because the reality is buyers have to pay 100% and not 75% and if they don't qualify because of the difference, then they should be buying something cheaper or waiting until they do. THis is just too risky in my view. And since CMHC is guaranteed by me as a taxpayer, therefore the lender in fact, I as a taxpayer lender am not being responsible loaning based on 75% of known expense.

As you said, disciplined homeowners will not be the problem.
For it is exactly that discipline which will ensure that they do not calculate based on 75% coverage of 100% known expenses.

 

[interested]

One other issue.

A few posts back I stated that I thought vacation/2nd homes were done at lower rates, perhaps 50% of the property value. This information was incorrect. I want to correct any misconceptions I may have lead people to believe.

I apologize.

 

[Eug]

I cannot agree with the 75% condo fee because the reality is buyers have to pay 100% and not 75% and if they don't qualify because of the difference, then they should be buying something cheaper or waiting until they do. THis is just too risky in my view. And since CMHC is guaranteed by me as a taxpayer, therefore the lender in fact, I as a taxpayer lender am not being responsible loaning based on 75% of known expense.

Except that it penalizes condo unit types. As others have said, home owners don't get dinged for ongoing maintenance costs in the calculations, but condo units do. The great thing about condos is you actually know how much your maintenance costs are. I have owned both a condo and a detached home, and it's a lot easier to calculate the monthly costs for a condo for obvious reasons.

Either the banks start using 100% of condo fees plus an estimate for detached home owners, or else they start using something like 75% of condo fees and $0 for detached home owners.

Let's go through some calculations.

800 square feet condo
$480 per month condo fees (60 cents per square foot, which is on the high side)
$0 per month for heating, since it's included in the condo fees
$100000 annual salary
$346/mo property taxes (at 0.8305702% per year)
$37500 downpayment
35 year amortization

RBC claims s/he can afford a home that is $495104 at 4% (+ $14415 CMHC fee), $439782 at 5% (+$12672 CMHC fee), $394354 at 6% (+$11241 CMHC fee), $359073 at 7% (+7718 CMHC fee).

So, by these calculations, it's 5.0X at 4%, 4.4X at 5%, 3.9X at 6%, 3.6% at 7%.

Let's choose that 4.4X figure, at 5%, with a mortgage of $439782. That's a mortgage of $414954, with a monthly payment of $2080.67.
At the end of the mortgage, there is still $389863 owing for the principal.

With that $389863 principal at the end of 5 years, to get the same monthly payment, the interest rate could jump to 5.52% for the next 5-year term.
However, if the interest rate jumped to 6%, then the monthly payment for the following term would be $2203.71, a difference of $123.04, which is 5.9% more than the previous monthly payment, an increase over 5 years representing less than inflation.
OTOH, if the interest rate jumped to 7%, then the monthly payment for the following term would be $2463.40, a difference of $382.73, which is 18.4% more than the previous monthly payment. That's significant.

However, with a disciplined home owner, one can pay down the mortgage as if the rate were closer to 5%, but with actual rates at around 3.69%, which means the principal at the end of 5 years is much lower than $389863.
The initial home cost is $439782 + $12672 CMHC, and the mortgage is $414954.
That means the monthly payment is 1754.13, with a interest rate of 3.69%. Being the disciplined homeowner, s/he pays $2080.67 a month, as if the rate were 5%. That leaves a principal of $361421.
Even if interest rates in 5 years were to jump to 7%, the monthly payment would only be $2283.68.

To put it another way, with someone making $100000 per year:
$2080.67 represents 25.0% of gross monthly income.
$2283.68 represents 27.4% of gross monthly income after five years, assuming that person gets no cost of living raises.
However, if that same person gets a 1.5% COLA raise each year, that means $2283.68 is only 25.4% of gross monthly income in 2016.

So, with today's interest rates, purchasing a place at 4.5X yearly income is not necessarily a big deal, even if interest rates increase to 6-7% in 5 years. It's quite manageable for someone who is disciplined. If you're not so disciplined, then maybe 4X yearly salary is more appropriate.

I do agree though that over 5X is excessive (although I've known people to handle even that fine too).