The Million Dollar Dilemma

Today’s online edition of the National Post looks at a home finance issue that may be most relevant in areas like Vancouver, Toronto or Montreal, but that demonstrates the importance of looking beyond interest rates and quick-qualifications when setting out to buy real estate. Although the article focuses on million dollar purchases, any home buyer should consider that strong cash flow may not offset a large downpayment – particularly if you plan to do work on the property, or are in a situation where you’ll be running into heavy land transfer taxes (or, as the article notes, if you are financing mortgage insurance AND a 12% second private mortgage to make up the 20% minimum on a million-dollar-plus home).

Read the article HERE.

Slow Debt Growth the Easy Way

With so much focus on the attempts of Finance Minister Flaherty and Bank of Canada governor Mark Carney to manipulate lending policies and rates, the easiest way to slow the growth of personal homeowner debt has been ignored. Higher equity requirements (either as a downpayment on a purchase, or equity in a refinance) would immediately reduce a homeowner’s liability exposure and carrying costs, and correspondingly reduce banks’ loan loss exposure.

The concept is not without risk, of course, in that it could dramatically cool the real estate market – borrowers would qualify for less expensive homes, might put off purchases until they can save the higher downpayment, or have to delay renovations or construction because they don’t have room to refinance their property. A blanket increase (from a minimum 5% downpayment to 10%) may therefore be too extreme, but a tiered one based on home price or lender qualification would work far better than the current efforts around rate or policy manipulations.

With other options floundering, this concept could gain traction in the months ahead, as more analysts, economists, and industry experts come on board. Even mortgage brokers, who benefit from larger and more expensive mortgages, are sort of coming around, as indicated in Robert McLister’s commentary in the Globe and Mail:

“Instead of quasi rate regulation, perhaps the government should impose higher insurance premiums or lower debt limits on less-qualified applicants who rely on government-backed mortgage insurance. That would immediately curb borrowing from marginal borrowers and temper home buying somewhat, sparing strong borrowers from higher interest costs.”

While  we disagree with the idea of higher CMHC premiums (which would put consumers even MORE in debt), lower debt limits for ALL applicants would be the surest, most immediate and most effective means of curtailing homeowner debt.

Seriously, what’s next?

So now that the Finance Minister has used his office to selectively target and influence public corporations, what should we expect him to do next? The Harper government is already spending tens of millions of taxpayer dollars on “Economic Action Plan” propaganda, will they now use similar resources on ad campaigns to pressure lenders to increase rates? If the housing market slows too much, will he ask banks to lower them instead?

The truth of the matter, is that the lending policy changes instituted by the current government – shorter amortizations, stricter underwriting criteria, and tougher documentation demands – don’t address the key element in the housing market equation: CASH. A buyer’s (or seller’s) equity position is the one thing that will force home prices up or down, without penalizing qualified buyers or interfering with the operation of publicly-held businesses.

Focusing on what a homeowner has to retain (rather than what they have to pay) is a focus on their downpayment. Raising the minimum downpayment requirement to 10% (from 5) would do three things:

1) Keep borderline buyers out of the market, reducing the need for lending policies designed for the lowest common denominator and procedures that are focused more on excluding clients rather than bringing them in.

2) Ensure that buyers start their ownership with sufficient equity in place to safely liquidate their home in the event of an emergency (10% equity would allow a seller to cover a 5% realtor commission and – in Toronto – a 5% double land transfer tax, and not suffer a loss), while leaving lenders (and CMHC) in a safer position against default.

3) Stabilize prices by capping buying power and reducing the buying range of prospective homeowners and investors, which may raise price pressures in lower-range homes but encourage higher priced properties to drop down into that market.

Now, just because we think a change to the downpayment requirement is what the market needs doesn’t mean that we’re right, but we find it very interesting that the option has never been entertained. Why not? Who is the one unregulated group that would strongly oppose such an effective stabilization of prices? Which group would be hurt most by buyers having to be realistic and responsible in their purchases?

In all of the discussions and debate about the housing market, the one group that has not been forced to change their way of operating, or take on a fiscal accountability in the real estate transaction, or face repercussions for actions that put buyers or sellers in dangerous debt positions, is the realtor and real estate development community.

House can’t be financed because of over-valuation? Bank’s fault. Bought firm but had to lose deposit because you couldn’t get financing? Should have been more realistic. There are far too many under-trained, inexperienced realtors in Canada, making deals and earning commissions without any stake in the game beyond the transaction. Particularly dangerous are realtors who have never experienced a down cycle, who have never had to work on a deal or invest part of their income in the sale of a property because their experience has been one of bidding wars and bully offers, who don’t see the need for conditions (not because they aren’t important, but because that prevents them from moving on to the next transaction).

It’s almost criminally easy to buy a house in Canada, mainly because those responsible for executing the transaction can walk away as soon as it’s done. Perhaps Mr. Flaherty could force realtors to take a stake in the game – becoming legally bound to ensure that prospective buyers are preapproved for financing, or committing to staying within a buyer’s range, under the treat of financial penalties. Maybe then we’d see an end to outrageous multiple offers, a stabilization of valuations, and a more responsible borrowing environment.

There are many, many realtors across the country who are suffering just like consumers are because they take a long-term view and believe in realistic valuations, affordable purchases and financially sound clients. They’re suffering because they’re not willing to list at the higher price (that will drop two weeks later anyway) or put in a firm bid (because the client is concerned about financing). Maybe THAT’s the area that our Finance Minister should be looking into.

But hey, it’s a lot easier to call up BMO and ask them to raise their rates, because THAT will solve the market problems, right? Right. Wonder which bank will be next…