The Sea Change in Canadian Mortgage Insurance

Few realize how dramatically Canada’s mortgage insurance market has changed. As any mortgage broker with a decade-plus of experience can tell you, borrowers are feeling this change in all too many ways.

Consider the numbers. As of the first quarter of 2021, “only 35% of outstanding residential mortgages extended by chartered banks were insured,” says CMHC. In 2012, this share was over 60%.

And insured mortgage balances just keep shrinking (down 5.3% year-over-year, according to OSFI data) while uninsured mortgage balances surge (+19%).

Source: CMHC

What’s causing this growing gap?

It’s been a “long-standing trend,” CMHC says, fuelled by:

1. Regulatory changes
   • Making refinances and properties over $1 million uninsurable was a huge game-changer, as was introducing new stress tests.
2. Soaring home prices
   • Supply/demand imbalances drove home prices to the sky, pushing more homes over the $1 million insurability limit.
3. Changes to portfolio insurance
   • The portfolio insurance ‘Purpose Test’ in July 2016 played a big role, as did November 2016 regulations requiring low-ratio insured mortgages to meet the same criteria as high-ratio mortgages. Couple that with increases in insurance premium rates and this all “contributed significantly to the downward trend in portfolio insurance,” CMHC says.

Uninsured mortgage volumes have ballooned as a result, a trend that remains in full force today.

Meanwhile, both high-ratio insured (-6.7%) and conventional insured (-14.7%) dropped in the first half of 2021, versus the same period in 2020.

That might make you wonder how the risk profile is changing in Canada’s mortgage market. Well, CMHC has data on that. Using historical data on mortgage originations from OSFI’s E2 Mortgage Loans Report, it finds that:

• On average, the loan amounts are higher for uninsured mortgages than for insured mortgages
  • That’s largely because uninsured mortgages have a “larger and increasing share of high-value residential mortgages of over $1 million,” CMHC notes. “The most noteworthy increase in newly originated mortgages was in the issuance of uninsured mortgages for purchases of property, which more than doubled the amount originated in the same quarter in 2020.”
  • As of the second quarter of 2021, about 75% of insured mortgages were under $500,000, versus 57% for uninsured mortgages.
• Uninsured LTVs are climbing
  • “Soaring property prices pushed the loan-to-value ratio distribution upwards for newly originated uninsured mortgages,” CMHC found.
  • But this did not affect insured mortgages in the same way.” In fact, in 2020-21, chartered banks issued insured mortgages with higher equity stakes than in previous years.
  • Among newly originated insured mortgages, 51.8% had an LTV from 90% up to and including 95%. This share is down from 55.4% in 2016, implying “higher equity stakes in newly originated insured mortgages,” CMHC says.
• Uninsured mortgages are increasingly being originated with higher total debt service (TDS) ratios
  • A 44% TDS ratio is typically the maximum that most lenders will entertain for a prime mortgage borrower. Yet, among mortgages originated in the first half of 2021, almost one in four (23%) uninsured mortgages had a TDS ratio over 45%, compared to just 5% of insured mortgages.
  • Meanwhile, the share of new uninsured mortgages with a TDS ratio of 40% or less has been “on a downtrend since the second half of 2020,” and CMHC says it decreased further in 2021.

What does it mean?

On the face of it, there’s unquestionably more risk in pockets of today’s uninsured mortgage market. Equity is an increasingly important safety net on higher-risk loans, and hence, some uninsured lenders will no doubt be put to the test as home equity shrinks in the next housing downturn.

Nobody can predict when that will happen, of course, but if inflation exacerbates our nation’s debt crisis, new supply finally offsets household formation and/or we end up with 150-200+ basis points of rate tightening, it’s not going to help.

Looking ahead, the insured/uninsured mix could change further, thanks to:

• A higher insurability limit
  • The Liberals promised to increase the limit from $1 million to $1.25 million
• A stricter stress test
  • OSFI and the Department of Finance review the minimum qualifying rate (currently 5.25%) next month. If they make the federal stress test tougher, more borrowers will shift to the uninsured market where—depending on the lender and mortgage type—it does not apply.
• First Time Home Buyer’s Incentive enhancements
  • The Liberals floated FTHBI loans, which could drive more insured business.
• Lower default-insurance premiums
  • Another Liberal idea that would incrementally fuel insurance demand (just what we need!).
• New funding methods
  • New uninsured funding mechanisms, like residential mortgage-backed securities (RMBS) and private default insurance, could someday lower uninsured funding costs, reducing the insured-mortgage cost advantage.
• Other regulatory changes
  • Things like higher capital requirements could shift the insured/uninsured balance “overnight.”

This shift from insured to uninsured mortgages argues for lower taxpayer risk, and that’s disputably been the case in terms of direct risk, notwithstanding all the lost government revenue from insurance operations.

But the sea change in Canada’s mortgage insurance regime begs countless questions. Are the policy benefits worth all the systemic costs? How big are the new latent risks that now lurk in our modern uninsured market? Have we simply shifted government-backed risks and increased costs on consumers, such that taxpayers are indirectly worse off? It’ll likely take a major housing downturn to reveal the answers.

–Robert McLister

Real Estate’s Double-Edged Sword

It’s easy to forget the power of leverage.

With $100,000 of income, a creditworthy borrower can now qualify for almost three times the mortgage they did in the early 1980s.

Decades of falling interest rates and expanding credit availability have made that possible, while acting as a giant lever for home values and mortgage activity.

The prosperity that’s been created in our industry this millennium is truly phenomenal, and it’s largely thanks to an unprecedented vertical climb in real estate.

Perhaps no chart illustrates the result of real estate leverage, imbalanced housing supply and rising incomes better than this one.

Source: Karl Schamotta, Chief Market Strategist, Cambridge Global Payments (adapted from a Federal Reserve Bank of Dallas dataset developed by Mack and Martínez-García)

Fifteen years ago, housing bears started warning that home prices were deviating from fundamentals. This graph shows what happened next.

Needless to say, the market had its own ideas about which “fundamentals” mattered.

And of course, housing bears said the very same thing ten years ago. Five years later they echoed the same warning. Today, they’re saying it again. But this time, they’re arguably getting closer to being right.

Catalysts change

Contrary to bearish disinformation, real estate values don’t rise on air. Prices—and our businesses as mortgage brokers—would never be at today’s heights if it weren’t for fundamental forces (falling rates, rising incomes, population growth, urbanization, supply shortages, etc.). Speculative mindsets aside, people pay ever more for properties because actual fundamentals give them reason too.

But fundamentals are a funny thing. They change.

When prices get so unattainable that Canadians making above-average incomes can’t afford even average homes, supply adjusts. It has to.

Of course, so far it hasn’t, at least not to any game-changing degree. But, given enough time and extremes prices, supply always adapts. That’s been true all throughout history, even if only for a short time—whether driven by developers in search of excess profits, by governmental policy or by shifting trends (like work-from-home or high-speed commuting, which makes building on cheaper land economically viable).

What’s at stake?

Canada’s economy relies twice as much on residential investment to fuel GDP, versus 20 years ago. For the first time ever, residential investment like new construction, renovation services, mortgage brokering and real estate services total over 10% of GDP.

In all, residential investment accounted for a remarkable 54% of GDP gains in the first quarter, according to Edge Realty Analytics.

Canada’s economy literally cannot afford its housing train going off the rails.

Watch those rates

That brings us back to our original premise: Leverage is a powerful thing. That is, until you run out of it.

The two-way sword of leverage cuts in the wrong direction when interest rates climb. And if one believes implied pricing in the bond market, rates are headed roughly 175 basis points higher in the next 24 months.

Take away rock-bottom rates after a parabolic price increase—let alone after other credit tightening (e.g., tougher qualifying rates or limits on amortizations, debt service ratios or non-prime lending)—and watch the magic of leverage work in reverse.

I’m not brazen enough to predict when the housing tide turns, but it will ultimately turn, for three reasons:

1. In expansionary cycles, inflation always exceeds the Bank of Canada’s 2% target long enough to warrant rate hikes.
2. The market will hit a point—if it hasn’t already—where average incomes are simply insufficient to qualify for financing on average homes.
3. Supply will catch up, be it from new listings by nervous sellers hoping to lock in windfall capital gains, government initiatives, or just good old developer greed (the productive greed that incentivizes development).

When all this happens, that’s when housing bulls, industry professionals and homeowners (those who perish the thought of losing their accumulated home equity) will witness the inevitable, a new real estate cycle…one where leverage works in reverse.

–Robert McLister

The Latest in Mortgage News: BoC Deputy Governor Says Rate Hikes Could Come Later Than Expected

Financial markets may be pricing in the first interest rate hikes as early as March, but they shouldn’t be too confident about that timing.

That was the message from Bank of Canada Deputy Governor Lawrence Schembri during a question and answer session following a speech on the labour market this week.

“There’s a lot of uncertainty about the timing of the closing of the output gap, so one should be careful not to assume it’s necessarily going to be the second quarter. It’s a range of six months—that’s our best estimate,” he said.

The Bank of Canada said last month that it expects economic slack to be absorbed in the middle quarters of 2022, which is when it anticipates the first move in the coming rate-hike cycle.

But labour market uncertainty is making it more difficult to pinpoint the timing of the first rate hike, Schembri argued.

“Our assessment of labour market conditions and underlying capacity and inflationary pressures is now more difficult,” he said. “Consequently, more uncertainty exists around the timing of when the output gap will close and inflation will return sustainably to our 2% target.”

Bank of Canada Governor Tiff Macklem sent a similar message this week in an opinion piece for the Financial Times. He noted that while the timing of the next rate hike is “getting closer,” it’s still very dependent on economic conditions.

“For the policy interest rate, our forward guidance has been clear that we will not raise interest rates until economic slack is absorbed,” he wrote. “We are not there yet, but we are getting closer.”

BoC Survey Shows Consumers Expect to Increase Spending “Significantly”

A recent Bank of Canada survey of consumer expectations found Canadians plan to increase their spending “significantly,” although they continue to remain cautious.

“Pent-up demand for some goods and services remains after long periods of restrictions. This is likely supported by extra savings,” the BoC reported. It noted that over 40% of respondents reported saving more than usual during the pandemic due to reduced spending.”

Respondents who accumulated savings intend to spend about one-third of these funds by the end of 2022—in fact, they reported having already spent about 10 percent of their extra savings in 2021.”

They also expect inflation to remain higher in the near term due to supply disruptions, but for the most part they don’t expect the situation to persist long term.

Nova Scotia Eyes Housing Tax for Out-of-Province Buyers

For those looking for more affordable housing in Nova Scotia, prices could become a little more expensive.

Nova Scotia Premier Tim Houston recently instructed the province’s finance minister to impose a levy of $2 per $100 of assessed property value on properties purchased by out-of-province buyers.

“The housing crisis is real and Nova Scotians expect us to act,” said Houston. “We’ll do what needs to be done to make sure Nova Scotians can afford a place to call home. We will not wait.”

According to the Canadian Real Estate Association, the average purchase price in Nova Scotia in October was $365,692. Based on a theoretical assessed value of $300,000, the proposed tax would work out to about $6,000.

In the capital of Halifax, the average price is even higher, having risen nearly 25% over the past year to $485,642 as of October.

DLC Group Reports $75 Billion in Funded Mortgages

Earlier this week, Dominion Lending Centres Inc. reported third-quarter mortgage volumes totalling $22.6 billion, a 61% increase compared to a year earlier.

Year-to-date funded volumes (as of Sept. 30) for the DLC Group of Companies—which includes Dominion Lending Centres, Mortgage Architects, Mortgage Centres Canada and Newton Connectivity Systems—were $57.9 billion, a 71% increase from a year earlier. Volumes are now at $75 billion for the past 12 months as of Sept. 30. By comparison, rival brokerage network M3 Group, which encompasses Invis, Mortgage Intelligence, Mortgage Alliance and Verico, reported 12-month funded volumes of $67 billion.

“We are very proud of our franchisees and mortgage professionals, Gary Mauris, Executive Chairman and CEO, said in a statement. “Their tremendous hard work has directly contributed towards another record quarter for the DLC Group. Similar to Q2 2021, the Q3 2021 results for funded volumes, revenues and adjusted EBITDA are the highest quarterly financial and operating results in the DLC Group’s 15-year history.”

DLC Group said it improved its leverage by repaying $3.2 million from free cash flows towards its Sagard credit facility, bringing its outstanding principal balance to approx. $27.8 million (CAD).

–Steve Huebl

How a Mortgage Pre-Approval Can Protect You from Rising Rates

Over the past month, we have seen several fixed mortgage rate hikes from the banks and other lenders.

Whereas rates below 2% were readily available one month ago for most uninsured 5-year fixed mortgages, the average is now around 2.79% at most banks. We all suspected rates would rise eventually, but this is happening much sooner than expected.

Do Rising Interest Rates Affect Mortgage Pre-Approvals?

Rising interest rates make mortgage pre-approvals much more relevant and meaningful.

Not only does a mortgage pre-approval give you the lender’s estimate of your borrowing power, but it also offers you an interest rate hold for up to 120 days in many cases. In times of steady or declining rates, you barely pay attention to your pre-approval rate. But these days, this rate hold can be a total game-changer.

If you are pre-approved for a fixed-rate mortgage, you may find yourself in a very fortunate situation when rates increase, because as long as your mortgage funds while your pre-approval is valid, your mortgage lender should honour your pre-approval rate.

This past week, we have clients who completed their home purchase with pre-approved 5-year fixed rates of 1.89%; a rate that simply does not exist anymore for uninsured mortgages.

Is it Worth Getting a Mortgage Pre-Approval for a Variable-Rate Mortgage?

Yes, it absolutely is worthwhile. The rate for a variable-rate mortgage is expressed as a discount to the lender’s prime rate – and that discount is what could change during your pre-approval period.

Today, it is reasonably easy to get a variable-rate mortgage at 1.30%. With the Bank of Canada’s prime rate sitting at 2.45%, your variable rate is expressed as prime minus 1.15% (a discount from prime of 150 percentage points).

Your pre-approval will lock in that large discount regardless of changes to the prime rate itself.

But if you recall, in 2020 we saw a sudden and profound change to the discount for variable-rate mortgages in the early days of the pandemic. The discounts actually disappeared, and if you wanted a new variable-rate mortgage it would have been at the prime rate, or even higher.

Fortunately, this didn’t last too long. In time, order was restored to the markets, and so were the variable-rate discounts. But this experience proved it is also good to pre-approve a variable-rate mortgage.

Do Some Variable-Rate Mortgages Offer Fixed Payments?

If you are pre-approved for a variable-rate mortgage, in most cases your payment will be immediately affected by changes to the prime rate. But some lenders offer variable-rate mortgages where the payment remains constant throughout the term of the mortgage.

That can cushion the blow to your monthly cash flow, at least until your renewal date. In this scenario—where the payment remains the same—if rates rise, more money will go towards interest and less towards the principal. The opposite is true, of course, when rates fall.

This sort of variable-rate mortgage is quite compelling these days. Being able to lock in your mortgage payment at 1.30%, versus 2.79% for the fixed rate alternative, is appealing to home buyers and refinancing homeowners who are cash flow-conscious, above all else.

What are the Benefits of a Mortgage Pre-Approval?

1. You have protection—or insurance—against higher rates during your pre-approval period (for many lenders, this can be up to 120 days). Let everyone else pay more than you, because your rate hold gave you every advantage with no disadvantages. If rates had fallen instead, you would still be a free agent and could benefit from those lower rates. So, with a pre-approval you can have your cake and eat it too.
2. You know your borrowing power. This is so essential when buying a home, in particular. One of the worst things you can do is fall in love with a home that is not within your budget. But if you do find yourself in that situation, you must consider other means to solve the problem. For example, you can source a bigger down payment or ask a family member to co-sign your mortgage application. There are numerous occasions when having a co-signer for your mortgage is beneficial.
3. In some cases, when you are pre-approved your credit has been checked and your application and documents have been reviewed. Note that this isn’t always the case, so be sure to ask your broker or lender. When you are house-shopping and find a property that you wish to make an offer on, you can ask your mortgage broker if the math works for that specific property. While this still isn’t a guarantee that you’ll be approved for the mortgage, the numbers can be run quickly in cases where you’ve submitted supporting documents and had a credit check as part of the pre-approval process.

The Takeaway

Many brokers and bankers do not go out of their way to offer mortgage pre-approvals. They feel it can be a waste of their time. After all, generally only a minority of pre-approved mortgages actually fund with the lender who pre-approved them, although that percentage increases in times of rising rates when many pre-approved rates are no longer available on the market. Additionally, a pre-approval often adds a slight premium to the rate.

But, in my view, this is short-sighted. A mortgage pre-approval is totally worth the effort. We owe our home-buying clients a mortgage pre-approval whenever possible. You can expect more people will jump on this bandwagon now that rates have started to climb higher.

–Ross Taylor

Home Sales Remain Strong in Big Cities as Demand Outstrips Supply

Housing inventory continued to fall well short of demand last month in most of Canada’s largest cities.

October numbers from some key regional real estate boards show no slowdown in housing demand as new listings continue to dry up and prices continued to rise.

In Vancouver, the supply of homes for sale dipped to a three-year low, while in the Greater Toronto Area the number of new listings was down by about a third.

“Both the ownership and rental markets have recovered from the relatively short–term effects of the pandemic, but competition for ownership and rental properties is once again tight,” said John DiMichele, CEO of the Toronto Regional Real Estate Board (TRREB).

Here’s a look at October readings from some of the country’s key real estate boards:

Greater Toronto Area

Sales: 9,783

• -6.9% Year-over-year (YoY)
• +8.1% Month-over-month (MoM)

Average Price: $1,155,345

• +19.3% (YoY)
• +1.7% (MoM)

New Listings: 11,740

• -34% (YoY)
• -12.9% (MoM)

“The only sustainable way to address housing affordability in the GTA is to deal with the persistent mismatch between demand and supply. Demand isn’t going away,” TRREB said in a release. “The tight market conditions across all market segments and areas of the GTA is testament to the broadening scope of economic recovery in the region and household confidence that this recovery will continue.”

Source: Toronto Regional Real Estate Board (TRREB)

Greater Vancouver Area

Sales: 3,494

• -5.2% YoY
• +11% MoM

Despite the decline from last year’s record figures, sales were still 22.4% above the 10-year average for October.

MLS Home Price Index for all property types: $1,199,400

• +14.7% YoY
• +1.1% MoM

New Listings: 4,049

• -27.3% YoY
• -21.7% MoM

“Home sale activity continues to outpace what’s typical for this time of year and the pool of homes available for sale is in decline. This dynamic between supply and demand is causing home prices to continue to edge up across the region,” said Keith Stewart, an REBGV economist. “Rising fixed mortgage rates should eventually help ease demand, but for now sales remain strong and buyers with rate holds will remain motivated to find a property for the rest of the year.”

Source: Real Estate Board of Greater Vancouver (REBGV)

Montreal Census Metropolitan Area

Sales: 4,320

• -24% YoY
• +17.7% MoM

Median Price (single-family detached): $515,000

• +20% YoY
• +2.1% MoM

Average Price (condo): $379,000

• +18% YoY
• +4.1% MoM

New Listings: 5,515

• +20% YoY
• -5.2% MoM

“The decline in sales to pre-pandemic levels is still attributable to the large deficit of active listings in the market. Make no mistake, there is still a significant number of buyers in the market and overheating is still a factor. We are seeing renewed upward pressure on prices across all property categories,” said Charles Brant, director of market analysis for QPAREB. “The recent announcement by the Bank of Canada of a hike in the key interest rate in spring 2022, sooner than expected, could help maintain some enthusiasm until then.”

Source: Quebec Professional Association of Real Estate Brokers (QPAREB)

Calgary

Sales: 2,186

• +24% YoY
• +1.3% MoM

Benchmark Price (all housing types): $460,100

• +9% YoY
• +0.5% MoM

New Listings: 2,500

• +2% YoY
• -53.6% MoM

“Moving into the fourth quarter, the pace of housing demand continues to exceed expectations in the city,” said CREB chief economist Ann-Marie Lurie. “Much of the persistent strength is likely related to improving confidence in future economic prospects, as well as a sense of urgency among consumers to take advantage of the low-lending-rate environment.”

Source: Calgary Real Estate Board (CREB)

Ottawa

Sales: 1,677

• -21% YoY
• +4.4% MoM

Average Price (single-family detached): $716,378

• +19% YoY
• +2% MoM

New Listings: 1,960

• +1.2% YoY
• -13% MoM

“While the number of units sold followed the traditional trajectory, the lack of supply continues to put upward pressure on prices, which are holding strong and steadily increasing,” said Ottawa Real Estate Board President Debra Wright. “Low inventory and a lack of suitable housing options restrict movement along the housing spectrum. Move-up buyers and downsizers have nowhere to go, so they stay in place, but we need that exchange of properties in the marketplace to free up supply for entry-level homebuyers.”

Source: Ottawa Real Estate Board (OREB)

–Steve Huebl