New Mortgage Qualification Rules – Unintended Consequences

Mortgage Interest Rate PuzzleWhen the federal government introduced ‘stress test’ rules in early 2018, the intention was to make sure that buyers would be able to afford their mortgage payments should interest rates increase by the time they need to renew. Basically, the new rules require that buyers prove that they could afford to buy their home if the mortgage rate were 2% higher.

Well, this worked all right: for example, the volume of homes sold in the GTA fell steeply last year, almost to the low point reached during the financial crisis, and 32% below the all-time high reached in 2017. Despite the fall in sales, prices have held up well, because the inventory of homes for sale has remained relatively low. But there are other consequences of the drop in sales.

Perhaps the biggest problem is that each real estate sale spins off economic activity in the form of renovators, movers, furniture and appliance sales, realtors, lawyers and so forth, and the reduction in this activity – estimated at about $64,000 per transaction – will ripple throughout the economy. Across Canada, there were 460,000 real estate sales last year, down from 515,000 in 2017, representing a reduction in economic activity on the order of about $3.5 billion. Not chicken feed to be sure. Given that we are nearing the end of a very long (if somewhat tepid) economic expansion, and likely facing a recession in the next 1-2 years, this is not a good thing.

Another problem for the Toronto area in particular is that larger numbers of frustrated buyers unable to buy means larger number of renters chasing the extremely limited supply of rental accommodation. It is well recognized that we have a serious rental housing crisis in Toronto, and it’s likely to get worse before it gets better. One thing that could help would be changes in zoning bylaws that restrict the number of rental units allowed. Converting older homes from single family to two, three or four units could add more rental space fairly quickly, but the bureaucratic barriers to getting this done legally are significant. It’s not that easy to change the bylaws, however, as there is a large NIMBY factor in many single family areas that don’t want to see an explosion of multi-unit housing. The rental situation promises to get very dicey over the next year or two.

The Bank of Canada has admitted that the impact of the new mortgage rules, combined with rising interest rates, was more serious than they expected. “Government help” as oxymoron.