Things have changed a lot since my parents purchased their first home in 1945, and not for the better. Liberalized lending rules, low interest rates and the double-income trap has left today’s families in a more tenuous position than ever before.
Demand for housing in major Canadian centres has been very strong since 2000, with prices increasing significantly faster than the Consumer Price Index. Looking at the chart below it is evident that these increases are far greater than increases in household income or other common indicators of inflation.
Causes of this housing price raceway are fairly limited in number. Demand is strong in the handful of large cities where population growth has been significant as a result of job growth, immigration from outside Canada, and in-migration from other parts of the country.
Demand is only one factor. Supply likely is not a problem as housing starts have continued throughout the past decade more or less to match demand, so price increases are not a function of any potential imbalance in the supply demand ratio.
Cutting the purse strings
Key to price increases is the supply of money directed towards housing and the ability of new borrowers to obtain financing. Over the past 13 years, interest rates fell, amortization periods increased, and these were concurrent with limited down payment requirements and low-risk mortgage lending supported by federal government-sponsored mortgage insurance. Mortgage lenders were ready, willing and able to lend ever-increasing amounts to new home buyers.
The chart shows percentage increase in Consumer Price Index in red and percentage increase in home prices in blue
Buyers were faced with a dilemma. If you entered the housing market during the past decade and in one of the growth cities you faced strong competition from other buyers, all of whom were supported by a growing mortgage money supply. The whole buying market was floated on an ever-increasing sea of money. More aggressive buyers supported by an ever-increasing ability to borrow would outbid a cautious buyer. No longer did price or the amount of a down payment matter – it became a place where the only factor was the level of debt borrowers could take on.
I am reminded of what a colleague of mine once said. He had previously been with Canada Mortgage and Housing Corp. (CMHC) and was of the opinion that contrary to the stated goal of making home ownership more affordable or accessible, the actual outcome of CMHC’s policies only was to make housing more expensive. The continued liberalization of lending policy has taken the housing market to a point where price is a function of the amount of debt Canadians can take on.
Families imprisoned by the double-income trap
As an example, when my parents bought their first house 68 years ago they expected to make a 50-per-cent down payment. To a very real extent, house prices were governed by the amount of money you had in the bank. They paid $6,000 in 1945, which limited the house price to three times their single household income and a $3,000 down payment.
A friend who is an economist further went on to say that when lending rules were liberalized to take into account two incomes in a household it in effect imprisoned families to needing two incomes to afford a house. This did not help families, but rather increased the price of housing, with the outcome that young families are hard pressed not to farm out their children to daycare or grandparents. Single-income households need a really high single income or they face very limited housing options. As individuals, families and a society we’re not any better off, and the outcome only has been higher prices.
At what point does ‘gaming’ become fraud?
A recent article by Canso Investment newsletter reported one troubling trend – “gaming” with CMHC’s online automated appraisal system, EMILI. The system was created in 1996 to allow lenders to quickly check if the house price involved in a mortgage transaction was reasonable. According to Canso, while this streamlined the process of mortgage insurance and origination, it also removed any human check and balance.
EMILI uses an algorithm which looks at the address, and particularly the postal code, and metrics of the house to be insured. The key variables are “the square footage of the house and the prior sale prices for the geographic area of the house.”
According to Canso, “there has been extensive ‘gaming’ of this system and excessive prices generated by this system. If a higher price is required for CMHC insurance coverage, the square footage, which is input by the lender and supplied by the mortgage broker, can be increased as required.”
“Gaming” is a polite term. What this really looks like is fraud. Having said that, the impact of this fraud will, for the most part, be limited to excessive lending on a single property, as opposed to the greater problem of excessive money supply for mortgages. This excess money supply has floated the buyers’ market to extraordinary heights with very few real winners. Recent homebuyers may be able to afford their mortgage payments – providing interest rates remain low during the amortization term. But some amortization terms in the past decade have reached 40 years and it’s unreasonable to expect interest rates to remain low three to four decades down the road.
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