Could changes to mortgage qualification rules be enough to cool the Canadian housing market? Or is something else needed? We will explore those questions, but first, we need to examine the current landscape of the Canadian housing market.
A recent study from TD Bank revealed that many Canadians would compromise their housing needs and wants, just to be able to afford a home. Thirty per cent of Canadians polled said they would purchase and live with loved ones outside their immediate family. Others are willing to sacrifice outdoor living space or the overall square footage of the house to get into the market.
Across Canada, prices are dropping month-to-month but are still at record highs. According to the Canadian Real Estate Association (CREA), the MLS Home Price Index fell 1.7 per cent month-over-month in July, but it was still up 10.9 per cent year-over-year. Buyers should not expect big bargains. They are still facing a market where affordability is a significant issue.
On top of the high prices, borrowing costs are rising. Interest rates have been hovering near record lows over the last two years to boost the economy. But that is no longer. The Bank of Canada has issued four interest rate hikes since March, including a supersized rate hike on July 13th. These hikes further exacerbate the affordability crisis for many Canadian homebuyers.
Before the coronavirus pandemic turned the Canadian economy upside down, major urban housing markets, like Toronto and Vancouver, typically priced out most first-time homebuyers and young families. Today, nearly every housing market in Canada has become too expensive for many hopeful homebuyers, leading to calls for government intervention and monetary policy action. Add in high prices and rising borrowing costs, and many homebuyers are sitting on the sidelines waiting for a more affordable home. There may be hope. According to TD Economics, home prices may drop by 19 per cent by 2023.
But could public policy serve as a panacea for the current housing boom? Or would other market-based factors, such as more supply, be more effective in making homes more affordable for Canadians?
Could Increasing the Mortgage Stress Test Cool the Canadian Housing Market?
Mortgage rates have been steadily declining for the last 40 years, falling from more than 20 per cent in the early 1980s. This decrease has allowed borrowers to take out larger mortgages, garner more housing options, and participate in cutthroat bidding wars.
With rising housing prices, the Office of the Superintendent of Financial Institutions (OSFI) intervened by increasing the mortgage stress test. A mortgage stress test applies to anyone applying for a mortgage. It evaluates your financial risk and determines if you qualify for a mortgage by ensuring you can afford an increase in interest rates.
Last year, Canada’s top banking regulator increased the mortgage stress test level to 5.25 per cent or the interest rate you negotiate with your lender plus two per cent, whichever is higher. This is up from the previous rate of 4.79 per cent.
According to the OSFI, the increase was necessary because “the current Canadian housing market conditions have the potential to put lenders at increased financial risk,” adding that it wants borrowers to ensure they are financially secure five years from now. “OSFI is taking proactive action at this time so that banks will continue to be resilient.”
A 25-year mortgage of $700,000 at a five-year fixed rate of 4.79 per cent would result in monthly payments of $4,006. At 5.25 per cent, the monthly payment would be $4,194. It might not seem like much on paper, but it can be a lot of money for families that are house-rich and cash-poor. Overall, it makes it harder to qualify for a mortgage, potentially reducing the number of qualified borrowers.
A year later, the impact is a little more clear. The stress test has pushed many Canadians to variable-rate mortgages as interest rates go up. Why? The stress test has typically been around the 5.25 per cent mark for variable-rate mortgages, while fixed-rate mortgages have been over seven per cent. This has caused many borrowers to take on a variable rate to qualify for a higher mortgage, even if they preferred a fixed rate.
Will the Canadian Real Estate Market Face Other Regulations?
What else could be done to rein in the Canadian real estate market? The National Bank of Canada suggests that the government could institute a ban on blind bidding. This consists of submitting bids on a property without knowing the value of competing offers. Proponents say this would effectively slow down the growth of real estate prices.
Others believe that raising interest rates would be a successful strategy to put a cap on price growth. Since it would cost more to borrow, homebuyers would not be incentivized to take out a larger loan than they initially wanted so they could bid for a bigger home.
Are Mortgage Rates Going Up in Canada?
As mentioned above, interest rates have indeed risen to combat inflation. Recent month-over-month drops in the interest rate may indicate that the Bank’s monetary moves are having the desired effect on inflation. On the other hand, the increased cost of borrowing has prompted some prospective homebuyers to move to the sidelines as they take a wait-and-see approach to navigating the market. And in true domino fashion, some would-be sellers also delay their plans to list until demand picks back up and prices rebound.
But while taxes, rates, and public policy pursuits might achieve some short-term gain, they might not produce a long-term solution.
New Housing Supply Might be the Only Answer
Christopher Alexander, President at RE/MAX Canada, and Elton Ash, Executive Vice President at RE/MAX Canada, are urging the government to be cautious when considering cooling measures. The most critical factor in explaining the housing boom is strong demand and low inventory.
As a result, these industry leaders put forth three recommendations that will be most effective in cooling the real estate market:
- Add a mandatory condition to every offer to ensure the purchase is conditional on financing.
- Institute an industry watchdog to monitor transactions where homes are sold well over the asking price.
- Create more supply.
The final option is something that federal policymakers may have heeded, but arguably not to the degree required. In the 2022 Federal Budget, the Liberal government proposed $4 billion over five years to launch a new Housing Accelerator Fund and $1.5 billion over two years to extend the Rapid Housing Initiative.
However, the concerning trend is that the year-to-date housing starts fell 5.5 per cent in July to 134,684 units, according to Canada Mortgage and Housing Corporation (CMHC).
Housing supply is going to be a monumental challenge. The CMHC found that approximately 3.5 million more affordable housing units are needed by 2030 to accomplish the federal government’s affordability objectives. This need is in addition to the 2.3 million new housing units already on track to be built by 2030.
Homebuyers Still Struggle to Access Canadian Real Estate Markets
Many housing areas, from British Columbia to Nova Scotia, are struggling through an affordability crisis. Statistics Canada reports that the median after-tax income of Canadian families of two or more people sits at $63,000, which may not be enough to purchase a property in many parts of the country. With or without regulations, it is becoming increasingly more complicated for households to buy a home, relying on generational financing to purchase a property.
This is why it is critical to work with a trusted and experienced REALTOR® to ensure you find a home that matches your needs and budget. In this market, you never want to go into it alone – you need an ally!