Higher Rates Are No Gift to Homeowners



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.

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Comments

  1. Comment avatar

    kim    

    Right on the money! Thanks for this. Most consumers have no idea what the government has just done regarding increased costs and reduced choice. It’s a conversation that I’ve had quite often lately.

     
    1. Robert McLister    

      Thanks Kim. Such conversations will be frequent this year. Paying 15-25 bps more for a 76% LTV than a 95% LTV is about as intuitive to most people as quantum mechanics.

       
      Comment avatar
  2. Comment avatar

    David Larock    

    Hi Rob,

    Re: your comment “We’ve yet to see evidence that higher government-imposed borrowing costs benefit homeowners long-term” – While it is always hard to prove that crises were avoided because preventative actions were taken, do you seriously think that our residential mortgage industry hasn’t required any changes since 2008?

    Further to that point, I am curious to know what, if anything, you think our regulators should do about our overheated housing markets? Or do you even think that they are overheated?

    I ask these questions because in your CMT posts you have come out against all five rounds of mortgage rule changes when each was announced. Has time changed your view or do you still feel that all five rounds were policy mistakes? And if you support any of the changes, which ones?

    You are an influential voice in our industry and while I have great respect for your knowledge and the hard work and dedication you show in the articles you write for CMT, I fundamentally disagree with your views on the mortgage rule changes.

    For my part, while I would prefer everything to stay the same forever because that would make my life easier, given the current period of extended ultra-low interest rates, our record household debt levels and the rapid increase in the number of borrowers who are qualifying by the narrowest of margins in the hottest regional markets, I think our industry’s survival depends on active management of the rules used to underwrite and insure our mortgages. And don’t those of us who work in that mortgage industry have the most to lose if our policy makers do nothing to address these worrying trends?

    Respectfully,
    David Larock

     
    1. Robert McLister    

      Hey Dave, Thanks for posting. A lot of “disagreement” stems from confusion about what’s actually being argued. In the context here, higher government-imposed borrowing costs refers to higher interest rates that result from bureaucratic destruction of Canada’s world-class securitization and insurance system.

      It just so happens that the rest of your points are covered in today’s story. 😉

      –> https://www.canadianmortgagetrends.com/canadian_mortgage_trends/2017/01/regulators-deserve-praise-and-reproach.html

       
      Comment avatar

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