Higher Rates Are No Gift to Homeowners

THINK OUTSIDE THE BOX:  If someone tries to convince you that policymakers’ attack on mortgage lending benefits the 70% of Canadians who own (or will own) a home, tell ’em “Show me the math.”

The government’s ongoing crusade against lenders is already proving costly.

Regulatory tightening over the last year has raised conventional mortgage funding costs by at least 25 bps, say lenders we’ve spoken with.

A ¼ point rate hike may not sound like a lot, but that’s $2,300 siphoned out of families’ pockets on a typical mortgage—over just one 5-year term.

If you’re a new buyer making an average down payment on the average Canadian home, regulators have just penalized you with $10,400 more interest over your amortization. (The average amortization is 18.8 years and the average first-timer’s down payment is 21%, according to MPC).

As usual, housing bears are jubilant over any reports of higher rates. They argue that steeper borrowing costs cut affordability, which lowers home prices, which save consumers more in the end. But that math, to put it in technical terms, is “whacked.”

For one thing, the fed’s new “stress test” makes many borrowers qualify at a higher 5-year posted, not the contract rate. And most people’s debt ratios are well below the stress test limit anyway. So raising the contract rate (which is what 2016’s insurance restrictions, capital rules, securitization fees and MBS limits do) has little effect on how much house most people buy.

Theoretically, a ¼-point bump in rates might keep only a few percent of borrowers out of the market anyway, and only temporarily (until they amassed a bigger down payment or more income).

Estimates of the price appreciation attributed to lower rates range from 15% (Bank of Canada) to over 34% (RBC Capital Markets). The latter’s research found that a 1 bps rate drop led to $266 in home price appreciation in Toronto.

Assuming the reverse were true, which isn’t necessarily the case, it would imply a $6650 price drop (over time) given a 25 bps rate hike. That might save a Toronto borrower $1,700 of interest, give or take, over a typical amortization. That’s a fraction of the extra interest they’ll now pay overall.

But then there’s the $6,650 of hypothetical savings resulting from the lower purchase price. Wouldn’t new buyers save that money?

Let’s assume they would. The problem, however, is that home values are a zero sum game. Someone else (the family who’s selling) would also lose that $6,650. Whose net worth is more important?

Even if home prices fell 5%—which wouldn’t happen because of a ¼-point rate hike alone—that would save our average buyer $4,900 throughout their entire amortization. That’s less than half the extra interest they will now pay thanks to the Finance Department’s evisceration of the default insurance and securitization markets.

And who’s to say home prices will even fall because of these rate surcharges? 3.5 million people are moving to the greater Toronto/Hamilton area in the next two decades. A ¼-point rate difference won’t stand between those families and a new home.

The facts stand on their own. When policymakers create higher funding costs for lenders, it is a “tax” on homeowners. In exchange for a notional reduction in the federal government’s risk exposure, consumers pay more. It does not make housing more affordable.

Note: This doesn’t even touch on policy side effects like loss of lender competition, diminished MBS liquidity (a risk in times of financial stress), the consumer spending impact and so on.

So if someone tries to convince you that policymakers’ attack on mortgage lending benefits the 70% of Canadians who own (or will own) a home, tell ’em “Show me the math.” We’ve yet to see evidence that higher government-imposed borrowing costs benefit homeowners long-term.

Robert McLister      January 3, 2017      CanadianMortgageTrends

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