Canada appears to be doubling down on its position that more demand will create affordability. Earlier this week, the Government of Canada (GoC) announced its “boldest mortgage reforms ever,” including its most ridiculous mortgage reform ever—first-time buyers using state-backed, high leverage loans to purchase $1.5 million homes. Confused? You’re probably thinking: First-time buyers usually don’t dominate the high-end luxury market, nor do they typically have the 1% income required to carry a high leverage loan of that size.
You’re smarter than most, so congrats. You’re also not alone, because the Department of Finance (DoF) wasn’t entirely sure either. The changes come at a time where banks are seeing mortgage arrears surge, and begs the question, who exactly does Canada consider a first-time home buyer?
Canada To Back Mortgages For $1.5 Million First Homes
Canadian first-time home buyers will soon be able to access much larger high-ratio loans. Starting December 15, 2024, the maximum purchase limit for a first-time buyer will be a whopping $1.5 million—nearly double the national average. For those unaware, a high-ratio loan is one where the borrower has a minimal down payment of less than 20%, and the lender is required to obtain default insurance.
The max will be raised 50% from the current limit. The GoC justified the move by stating the maximum hasn’t been increased since 2012, though it’s unclear if they understood why the limit was originally set. Back then insured mortgages weren’t exclusive to first-time buyers, but included refinances as well. The intention was to set a limit and deleverage, which is very different from the maximum that first-time buyers need.
How Much Is A Home These Days Anyway?
The narrative here is that first-time home buyers are facing limits on their purchasing power with just a $1 million budget. That sounds plausible at first, unless you’re in the industry or own a home. Let’s go over the numbers.
Canadian real estate has climbed dramatically over the past few years, but not to the extent the government presented. A benchmark, or typical, home across the country was $717,000 this past August, or $521,000 for a condo apartment. They have a lot of options in their budget.
Perhaps it’s for households in more expensive cities? The price of a benchmark condo in Toronto ($667,000) and Vancouver ($768,000) are both considerably below the current threshold. If you’re pondering how much one has to make to get to the new threshold, you might be onto something.
To hit the new limit, a first-time buyer would have to be amongst the wealthiest households in Canada. A minimum annual income of $250k would be needed just to carry the maximum loan. That’s the highest tax bracket in Canada. They also need to make more to cover the taxes, maintenance, and insurance—putting them in the top 1% of Canadians. If the 1% can’t afford their first-home without a state-backed high ratio mortgage, the other 99% of Canada needs to realize it’s time to find a new country. Obviously that’s not the case.
How Much Do Canada’s Current First-Time Home Buyers Make?
Let’s take a peak at actual first-time buyer finances. Greater Vancouver is home to the first-time buyers with the deepest pockets, so let’s start there. According to the Canadian Housing Statistics Program (CHSP), immigrants make slightly more expensive purchases as first-time home buyers at a median price of $680,000 on an income of $136k. That’s roughly half the price and income of the new limit.
Parental help is common and those budgets are bigger, but not as big as the GoC thinks. In Greater Vancouver, a median first-time home buyer with 3 or more people on the mortgage, spent $778,000 and had a combined income of $172,700. Those incomes are considerably higher than a typical household, but almost 6-figures short of approaching the new threshold. Clearly this isn’t about generating more first time home buyers, and if it is—it’s a handful of the wealthiest households in the country that probably don’t need state assistance. What gives?
Mortgage Insurance Protects Lenders From Bad Loans, Not Buyers
Let’s circle back and clarify something important about foreclosures and mortgage insurance. Foreclosures are rare when the market rises, as has been the case for 30 years. It’s not that there’s a lack of households struggling with payments during this period, but they’re able to sell, and maybe even turn a profit, before a default. Rising defaults occur when borrowers can’t find a buyer, either they can’t afford to lower the price or buyers can’t afford to pay more. In other words, delinquencies are indicative of liquidity not credit quality.
Mortgage insurance protects the lenders from losses. In the rare event a foreclosure occurs and the lender recovers all funds, the surplus is returned to the borrower and insurance doesn’t kick in. When the lender fails to recover the full amount they’re owed, the insurance tops up the amount recovered to correct the losses. The insurer can then pursue the borrower for the payout. In short, mortgage insurance protects the lender, not the borrower.
Another misconception is that mortgage insurance is only used for high ratio mortgages. Mortgage insurance is required for those with less than 20% equity, but lenders can purchase insurance for loans with much more equity. It’s normal risk management for the lender to insure a share of their portfolio. Over the past 30 years, it’s been rare for significant payouts since prices largely climbed. However, that’s changing fast.
Canadian Banks Have Seen The Mortgage Arrears Rate Surge
Canada’s Big Five banks are fearlessly rushing into risk, and Greater Toronto condos are an alarming example. The Big Five backed 75% of investor mortgages last year, most are cash flow negative. Market rents aren’t high enough to cover the carrying costs, a sign they overpaid. Vacancy rates are also rising and now sit higher than pre-pandemic rates, limiting price growth. A point that reinforces the evidence that population estimates are overinflated, but we’ll take a deep dive into that next week.
Why did investors overpay so much? Investors in this market represent at least 70% of demand for pre-construction, but a significantly smaller share own them a year after completion. The assignments are secured with little capital or verification that the buyer can close them, since they’re trying to flip the units to end users. Weak demand has many forced to close, losing money as a landlord while they wait for a buyer.
Extra inventory and weak demand help to push prices lower, compounding the issue. Remember those pre-sale buyers who could barely afford to close? That problem gets worse if their lender refuses to assess the property at the purchase value, and they need to cover the loss before they can try to close on a property that they can’t afford. The issue has become so prevalent that lenders are now turning a blind eye and engaging in controversial “blanket appraisals,” where a lender or two will agree to recognize a value. If it sounds sketchy to you that they are willing to recognize inflated values, you’re right. It is.
Canada’s bank regulator has coincidentally delayed the country’s adoption of global standard risk reporting. The changes would have recognized default risk of investors mortgages, and they seemed keen to implement it ahead of these issues. Until they weren’t, it’s a real mystery why.
You’re probably thinking: Surely there would be signs of this crisis, right? Oh, there is. No one’s paying attention.
RBC reported the mortgage arrears rate hit 0.24% in Q3 2024, more than double the rate two years ago. It’s now the highest going back to at least 2017, a lofty rate but the major concern is the velocity. The level is less concerning than the velocity, since fast movements leave less time to adjust, amplifying the damage.
Canadian Mortgage Arrears Are Ripping Higher At RBC
Canadian residential mortgage arrears rate at RBC, Canada’s largest bank. In percentage points.
Source: RBC; Better Dwelling.
Greater Toronto real estate tends to have high demand, leading to a lower arrears rate than the national average. Not the case these days, with RBC reporting the rate climbed to a whopping 0.27% in Q3 2024, surging 6x over the same period. If Canadian mortgages are experiencing a shit storm, Toronto is in a full blown Category 5 shitticane.
Toronto Real Estate Has Seen Mortgages In Arrears Surge
The Greater Toronto mortgage arrears rate at RBC, Canada’s largest bank. In percentage points.
Source: RBC; Better Dwelling.
The share of investor mortgages in arrears is unclear but it’s likely substantial. Canada’s banks have been asked to be generous with actual homeowners, extending amortizations longer than the lifespan of the owners. In any case, the issue is the same—this is about a lack of liquidity. Sellers can’t lower their price to find buyers and buyers can’t increase their budget. Raising the insured mortgage limit won’t give buyers more income to service the debt.
What does this have to do with first-time homebuyers who need $1.5 million loans? When we picture first-time home buyers, we picture young-ish households just getting started. Most people don’t realize a first-time buyer is also a couple that separates, or anyone that lives in a home that they or their partner didn’t own for the past 4-years, a definition that leaves a lot of flexibility on interpretation. There’s also the increase in “residents” that find themselves having to leave shortly after arriving, becoming an impromptu landlord. Heck, sometimes it’s just a fraudulent declaration—Equifax Canada claims they’ve seen a surge, with monthly fraud flags hitting 15,000 to 24,000 mortgage applications per month.
Speaking of the dicier side of Canada, this seems like a convenient solution to the money laundering losses. Let’s say FINTRAC found a part-time casino worker who reported a $375k income with most of their salary coming from Beijing. They purchased their first of three homes in a short period of time, leaving the agency with allegations of fraud. Sounds ridiculous, but it’s one of the more tame scenarios in the widespread mortgage fraud allegations against HSBC Canada, whose acquisition by RBC was approved by the DoF despite knowing they were under investigation when they sold. Could a bank insure the loan before the government takes action or the person flees?
Or the case where FINTRAC alleged the world’s largest car theft gang was laundering funds through casinos and housing. Clearly after cracking down on the car thefts, there’s going to be some cash flow difficulties. Could lenders insure those mortgages in the event they fear a government crackdown may impact the cash flow of that “first-time buyer”?
It’s obvious first-time home buyers aren’t being held back by the limits to their 1% incomes. Banks on the other hand need some more insurance to protect their mortgage portfolios.
Speaking of portfolios, some of Canada’s risk rules are now being applied at the portfolio-level rather than to individuals. For example, OSFI’s recent announcements on mortgage debt being a multiple of income is a portfolio-level rule. The combined mortgage debt needs to be within the limits determined by the combined income, as opposed to applying it to each household. They just need to balance high leverage borrowers with lower leverage ones.
We reached out to Canada’s DoF for more information about the portfolio application rules. Unfortunately, they didn’t appear to have much information but got us in touch with Katherine Cuplinskas, deputy director of communications for the Deputy Prime Minister.
“On background – yesterday’s announcement means more people can qualify for a mortgage needing a downpayment of less than 20 per cent,” explained Cuplinskas, delivering a non-contextual response to the direct question of portfolio application.
Adding, “further details on implementation will be announced in the near term.”
For those not fluent in Canadian Government, it means their bosses didn’t tell them anything. That’s unusual for a policy that would have typically required significant consultation and an impact report. Sources at OSFI and CMHC, who declined to be named, also claim they were blindsided by the announcement. Members of Parliament contacted have also been trying to determine who knew this policy was coming, but so far haven’t found anyone aware prior to the announcement.
It’s unclear exactly why this policy was rolled out. It certainly isn’t because the top 1% of households are struggling to purchase their first-home, and it’ll revive the market. The surprise announcement in the current environment makes it most likely a lender mitigation tool for a demographic of buyers we don’t think of as first-time home buyers. Ones who suddenly have very high incomes, where a lender is concerned about the legitimacy of the funds.
So many questions. Unfortunately the government’s only answer was more people will be able to buy homes with less than 20% down.
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