Recap & Outlook: Vancouver Housing – Part III
We continue readdressing a relevant domestic issue: Vancouver housing and whether it is a good investment. As a reminder, we are covering four topics: 1) Foreign Capital, 2) Interest Rates and Lending Standards, 3) State of the Current Market, and 4) Our Conclusion.
These topics are a follow-up to the reports we wrote in July 2015 and in August 2016. In those reports, we characterized local real estate as undoubtedly expensive and an asset that lacks the characteristics we look for in an attractive investment. By our definition, we concluded that owning local real estate was not an investment but a speculation on the continuation of foreign capital flow, low interest rates, and low lending standards. This week, we comment on interest rates and lending standards.
Interest Rates and Lending Standards
Interest rates have risen: The interest rate on a five year government bond is important because it determines the interest rate charged on mortgages. This key interest rate has increased from a low of 0.57% in January 2016 to 2.24% today.
- Mortgage payments are increasing: To put the above in perspective, the above rate increase applied to a typical 25 year mortgage would make the monthly mortgage payment ~$2,400 vs. ~$2,000 previously.
- Fixed rate mortgages: Even fixed rate mortgages (typically 3-5 year term) are subject to renewals based on the interest rate at that time. Today, Canadians will be renewing their fixed rate mortgages at a higher interest rate (and higher mortgage payment) for the first time in over a decade.
- Can Vancouverites afford this? With many Vancouverites previously borrowing the maximum mortgage they can afford, this rate increase could make many related monthly mortgage payments unaffordable.
- Rates to keep rising? With inflation accelerating, many economists believe we have reversed the 37 year trend of lower interest rates and are in the early-stages of a new trend of rising interest rates. If this happens, mortgage payments will continue increasing.
Lending standards have tightened: Since our August 2016 report, the government has significantly restricted who and how much banks lend to. This began in the fourth quarter of 2016 with new regulations on mortgages insured by CMHC (borrower making <20% down payment). Incremental regulations came in January 2018 when OFSI scrutinized uninsured Canadian mortgages (borrower making >20% down payment). These regulations were:
- borrowers must qualify for a mortgage based on a higher than current interest rate;
- lenders are to be more diligent in the income verification of borrowers;
- borrowers can’t borrow to make their down payment.
This means that a prospective home buyer who could get access to a $1,000,000 mortgage previously can now only access a $750,000 – $900,000 mortgage. Also, the stricter income verification means that many Vancouver based borrowers can no longer access credit.
“This means that” changes in government based lending standards have significantly restricted who and how much banks may lend to Canadians to buy real estate. Higher interest rates equal higher mortgage payments which can make prior mortgages unaffordable. While interest rates are difficult to predict, many economists believe interest rates will continue rising. In summary, the era of loose lending standards and low interest rates instrumental to the booming domestic housing market may be ending. Next week, we report on how the changes in foreign capital, interest rates and lending standards are currently impacting sales and prices in the Vancouver real estate market.
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