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December 15, 2017 | The Big Stick

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Just 16 more sleeps now until B20 lands. What the new stress test will do to residential housing is a giant topic at the moment. Will it tank the market, just stall it, or end up being as useless as the last stress test was for high-ratio borrowers?

To summarize: starting in a couple of weeks banks must ensure all borrowers can service their loans if interest rates shoot higher. To do so, people applying for mortgages will have to prove (with their income) they can make the payments at the current market rate + 2%. So, come January it’ll be as if mortgages had just popped over the 5% mark. Compared to the 2% loans available last winter, that’s an extreme change.

The federal bank regulator is doing this, largely, because of the Bank of Mom. After a similar test was brought in for kids with less than 20% to put down, CMHC-insured loan volumes crashed more than 40%. Unable to pass that test, the newbie buyers with small down payments were borrowing money from parents (and other unsavoury sources) in order to escape it. As a result the banks found their uninsured mortgages  were exploding higher, but that a lot of borrowers were actually high-risk – leaving them more exposed.

So the regulator said enough, already. Everybody will be tested, regardless of the heft of the down payment – no exceptions. And here we are. Also notable is that anyone with an existing mortgage who, after January 1st, wants to change lenders must also go through the stress test process. Astonishingly, that amounts to 2.7 million households who will be locked into their existing lenders.

So what happens now?

The mortgage industry says about 18% of overall credit will be reduced. More than 100,000 buyers won’t get the financing they want. Roughly half of those will end up buying nothing.

The real estate industry (CREA) says this will reduce overall sales next year by 5%, that prices will come down, 12,000 jobs in the industry will be lost and the economy will be impacted with a reduction of $1 billion in activity.

The Bank of Canada estimates about 10% of home buyers will be affected because that’s how many in 2016 would not have qualified under the new rules. This would represent some 36,000 lost sales, or $15 billion worth of borrowing.

Veteran mortgage guy and RateSpy founder Rob McLister says one in six borrowers will be caught in the stress test process next year, but that they “won’t just give up.” In fact, determined to buy real estate despite the odds, they’ll make some very bad choices. This will include taking loans with 30-year amortizations (more interest), dealing with a non-regulated lender (more interest), not shopping for a better rate when they renew (more interest) or dealing with a credit union (probably more interest).

And he makes this prediction: “Make no mistake, some home prices may drop for a while as B-20 trims demand (temporarily lowering debt ratios). But prices will surge to new records once again, leaving indebted borrowers in a worse—less flexible—position than today.”

If this is true (beats me) then B20 will make life as we know it more pooched. Real estate sales and prices will continue to rise, hurting affordability. People struggling to buy some will borrow more and save/invest less. Consumers will be shut out of making choices that actually improve their financial situation. The banks and CUs will make out like bandits. The unregulated shadow banking business will flourish as never before. Our debt gasbag will inflate further until, one day, we blow up.

And speaking of that, we just hit a new high of 171% in debt to disposable income, which exceeds the worst level those irresponsible Americans achieved just before that real estate market imploded. Now households owe $2.11 trillion, which is bigger than the entire economy (that takes some effort). Most of it is mortgages, of course. To date we have financed about $1.4 trillion against real estate, and the pile continues to grow larger.

Naturally, as interest rates increase (three more Fed hikes in 2018 and at least two in Canada) the cost of debt servicing increases. Disposable income drops. The economy is affected. Last year, for the first time in eight years, family net worth fell. And people still expect housing prices to increase?

Logic tells us that when rates went down and credit flowed, house lust flourished and property values rose. Now central banks are tightening and the regulators are freaking. We’re at unheard-of levels of borrowing, and crap houses cost $1 million. B20 is the big stick intended to beat the natives into submission. If this fails, round up the horses.

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December 15th, 2017

Posted In: The Greater Fool

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