Historical article note: This article was originally published on 2019-09-26. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
With the federal election approaching, the candidates have made their appearances: some are trying to appease voters who dislike the wealthy, promising to continue targeting non-residents without voting rights; others are trying to please voters eager to buy homes, promising to loosen mortgage policies. Foreign buyer taxes and mortgage policies can be considered crucial national instruments and are not easy to change. It is advised that everyone should not place their hopes of buying a home on the promises made by candidates during election campaigns, and should rationally consider how changes in mortgage policies and interest rates will affect purchasing decisions.
The level of real interest rates determines the cost of buying a house. Expectations for interest rate trends determine how long people will hesitate when it comes to buying a house. Mortgage policies are set by banking regulatory authorities, and their strictness depends on the credit risk of banks.
Many readers hope that I will talk about my views on current interest rates and mortgage policies. Since 2019, the direction of interest rates has taken a 180-degree turn. Compared with last year and this year, expectations for interest rates have undergone a fundamental change. Mortgage policies have not changed, and the Canadian federal government has provided only a small amount of support for a very few first-time homebuyers, and that is all.
01 The actual interest rate of mortgage loans decreasing is beneficial to debtors
Buying a house, whether for self-occupancy or for renting out, is a financial decision. People who rent need to compare the cost of renting with the cost of buying. From a purely financial cost perspective, we can use an online calculator to determine after living in a certain city for how long the cost of renting will exceed the cost of buying, that is, to find the "break-even" point. At https://www.genworth.com.au/lenders/lmi-tools/buy-or-rent-calculator/, you can enter the rent in your city, the average apartment price, down payment ratio, interest rate, etc., and it will calculate it for you. Taking Toronto as an example, this break-even point is around 3 years, meaning that if you live in Toronto for more than 3 years, the total rent expenditure will exceed the 3 years of mortgage interest + property tax + maintenance fees. The longer you rent, the higher the expenses and the greater the net asset loss. The lower the interest rate, the lower the cost of buying a house. After the actual interest rates fell in 2019, the cost of buying a house decreased, benefiting not only existing borrowers but also allowing potential buyers to see that, in the context of continuously rising rents in Toronto, buying a house is financially more worthwhile.
02 The expectation of loan interest rates changed from raising rates to cutting rates
Throughout 2018, the Federal Reserve firmly believed in raising rates, resolutely deleveraging, and reducing its balance sheet. By 2019, under presidential pressure, it made a 180-degree turn, and by September 2019, it had cut rates twice within the year and stopped shrinking the balance sheet. The US bond yields experienced several instances of short- and long-term inversion. The changes in the Federal Reserve's rates and balance sheet policies affected Canada as follows: Canadian bond yields fell, leading to a decrease in mortgage interest rates, and people expected the Bank of Canada to follow the Federal Reserve in cutting rates.
Explanation of the key economic terms above:
Rate cut: entirely a man-made manipulation. Rates are cut even without deflation and without high unemployment. The Federal Reserve decides; any forecast is useless.
Balance sheet reduction: Selling the assets on the Federal Reserve's balance sheet, namely U.S. Treasury bonds and other debt instruments, returning the bonds to the market, withdrawing cash from the market, and reducing the assets on the Fed's balance sheet is called balance sheet reduction. Stopping the balance sheet reduction now means stopping the withdrawal of circulating money, and the deleveraging action has been aborted.
Yield curve inversion between short-term and long-term bonds: When a 5-year bond yields more than a 10-year bond, or the 5-year loan rate is higher than the 10-year loan rate, this is called inversion. This situation indicates that banks are unwilling to issue long-term loans; everyone is operating in the short term, quickly in and out. Companies do not plan long-term, and loans are not aligned with long-term investments, leading the economy into a recession. Reflected in mortgages, this means the 4-year loan rate is lower than the 2-year loan rate, leaving ordinary people confused.
Alright, since 2009, the country, companies, and households have all borrowed heavily taking advantage of low interest rates. Between 2017 and 2018, interest rate hikes and deleveraging scared the major debt holders, prompting them to quickly repay loans, otherwise interest would grow faster than income, leading straight to bankruptcy. However, this round of deleveraging was abandoned midway. The Fed's decision to raise interest rates was correct because the world had already reached the peak of the long debt cycle; without deleveraging, some heavily indebted players would have had to borrow new money to pay old debts and could take reckless actions. Unfortunately, the action was abandoned halfway, which will prolong this long debt cycle and push the debt peak higher. Big debt holders catch a breather, while those who haven’t borrowed hesitate: should they borrow or not? In any case, keeping deposits definitely loses out; borrowing money risks the Fed potentially reversing policies and starting to hike rates again for deleveraging after next year’s elections. You see, it's so difficult to navigate as a person, caught between a rock and a hard place.
My own view: The decision to borrow relies on two conditions: 1. Whether you have the ability to borrow; if unsure, apply for a pre-approved loan. Approval indicates you have borrowing ability; denial means turning to private lenders is risky and not part of normal practice. 2. The interest rate is an important economic decision indicator: borrow when rates are low; deposit when rates are high.
03 Mortgage policy has not changed; all favorable news is false.
Let me first tell a joke from the Chinese community. On July 18, 2019, the central bank lowered the benchmark fixed interest rate for 5-year mortgages from 5.34% to 5.19%. The next day, articles started being published on public accounts in the Chinese community with good news: banks are relaxing mortgage policies.
If you haven't laughed, I will explain some basic common knowledge that can make you laugh.
The central bank, Bank of Canada, determines the rise and fall of the 5-year benchmark mortgage fixed rate based on the average 5-year mortgage rate of commercial banks. If the average 5-year fixed rate of the five major commercial banks drops from 5.34% to 5.19%, the central bank will decrease it. In other words, the central bank itself will not adjust this rate. In Canada, the central bank is a parallel institution to China's People's Bank.
The regulator responsible for bank mortgage policies is OSFI, not the central bank. The mortgage policy numbered B20 implemented by various commercial banks is issued by OSFI. The parallel organization of OSFI in China is the China Banking Regulatory Commission.
Interpreting the central bank’s lowering of the 5-year fixed mortgage rate as news that banks are relaxing lending policies is ignorant and blindly optimistic. The problem is that a trend has formed in the Chinese community: as long as it's good news, people don't investigate its truth, only willing to spread rumors and unwilling to hear the truth. There are particularly many amateur journalists in the Chinese community, whose articles either translate local media or make things up; they don't even take the time to consult professionals, and their headlines must be sensational at all costs. Everyone should develop the habit of asking professionals about professional issues. Being deceived by news has become normal, so make sure to keep your eyes open.
There are three main reasons for the rise in housing prices, and even the occurrence of a bubble: 1. If the price increases by more than 8% for two consecutive years, it will attract speculators to rush in and out quickly, further driving up housing prices. This kind of price increase is the most fragile; 2. When banks loosen mortgage policies or have too high a tolerance for fraud, allowing people without repayment ability to buy houses, it drives up housing prices. This kind of increase is not only flammable but also explosive. The United States experienced it once, and it is believed that no other country would dare allow banks to push up housing prices again; 3. Rising rents drive up housing prices. This is solidly driven by demand, and even if the government suppresses it, it is only a temporary measure. What the government, residents, and real estate investors prefer most is: an annual price increase below 8% to prevent speculators from entering to arbitrage; banks acting as mortgage gatekeepers and not allowing borrowers with poor financial capacity to slip in; rent rises driven by population growth, attracting talented and wealthy people to settle. Banks play an important role in ensuring the long-term and healthy development of the real estate market. People who hope for interest rates to drop and for banks to relax lending policies are usually stakeholders. This unrealistic expectation leads WeChat public account editors to pander and write recklessly in order to get reads and shares. Housing prices are not driven up by hype, nor will they be driven down by anyone, and it is even less likely that banks will be persuaded to change policies. Public accounts that produce sloppy articles are depleting their credibility and reader loyalty and need to be recharged. Currently, bank mortgage policies are very moderate, meeting the needs of homebuyers without causing housing prices to rise by 8%. Regulatory authorities have no reason to disrupt the existing balance.
04 Interest Rates and Housing Loan Policies' Impact on the Real Estate Market
Interest rates are the determining factor in the cost of buying a home. Over the past 10 years, interest rates have remained low, which benefits homebuyers as well as borrowers with existing mortgages. The five interest rate hikes by the Bank of Canada from 2017 to 2018 did not change the overall upward trend in condo prices in the Greater Toronto Area. From 2019 to 2020, even with interest rate cuts, the decreases were not significant and would not have much impact on purchasing decisions.
The mortgage policy, since January 1, 2018, has reduced the ability to purchase homes. For properties beyond the range of average income, the transaction volume has been greatly affected. This situation is unlikely to see significant improvement in the next 2-3 years. However, four years later, once condo prices in most areas approach an average of 700,000 per unit, the high-priced housing market will become active again.
In most regions, families with median annual income spend 50% of their income on mortgage payments per month, but the mortgage burden for a CONDO only accounts for 32% of the income. Therefore, CONDO prices are within the reach of both investors and first-time homebuyers, leading to intense competition, keeping CONDO transactions active, and prices gradually being pushed higher.
In April 2017, after the Ontario Liberal Party implemented a policy discriminating against non-resident homebuyers, a spectacular drop in housing prices of 18% occurred within six months. Non-residents stopped buying, speculators were driven out, and the wealth of the Greater Toronto residents paid the price. After reviewing and summarizing, we have some lessons worth noting: 1. Be cautious entering the market when house prices have increased 8% for two consecutive years; 2. Land preserving its value is a myth—low-density properties with large land areas drop faster than downtown CONDOs; 3. Politicians will do anything for elections; 4. Rising interest rates do not necessarily lead to falling house prices, and falling interest rates do not necessarily lead to rising house prices; 5. Renting is truly essential, buying a house has never been essential, negative market news can instantly turn the perceived 'necessity' of buying into 'unnecessary,' while rental vacancy rates and rents remain unaffected by sentiment, persisting consistently.
Summary: Remembering past events serves as a guide for the future. After experiencing local housing policy changes, interest rate fluctuations, and tightened mortgage rules since April 2017, we should have an objective and systematic understanding of the real estate market's patterns. Ignore sensational headlines like 'It's too late if you don’t buy now' or 'The government has loosened mortgage policies' from unverified reporters. When you feel the bank’s policies are very rigid, it indicates that the real estate market is healthy. There is only one good timing to buy a house: when you are materially and mentally prepared, the opportunity becomes yours; otherwise, it is someone else's. Be a rational homebuyer.