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Toronto’s million-dollar homes reveal risks of Bank of Canada’s flirtation with lower rates. The real cost of a $1 million home: Toronto buyers resort to sub-prime loans as prices soar
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Toronto’s million-dollar homes show the risks to the Bank of Canada’s flirtation with lower interest rates.
On the same day Governor Stephen Poloz signalled a January rate cut may be sufficient to offset the effect of lower oil prices on Canada’s economy, figures revealed the average price of a detached home in the city surged past $1 million for the first time.
A booming real estate market in Toronto and much of the country underscores the risk of combating the oil price shock with cheaper borrowing costs that may only fuel a housing bubble and aggravate household indebtedness.
“When you add all this stuff up, you are sort of left with the notion that monetary policy is a pretty blunt instrument for this,” said Mark Chandler, head of fixed-income research at RBC Capital Markets.
Without mentioning real estate, Poloz cited easing financial conditions in his decision to keep rates unchanged at 0.75% after the bank’s announcement Wednesday. He said risks to the financial system haven’t changed since his last rate decision in January.
“This easing is reflected across the yield curve and in a wide range of asset prices, including the Canadian dollar,” the Bank of Canada said. “These conditions will mitigate the negative effects of the oil price shock, further boosting growth through stronger non-energy exports and investment.”
Poloz surprised markets Jan. 21 by cutting interest rates by one-quarter percentage point, in a move he said was intended to provide “insurance” against the oil price shock. A rate cut would also help protect against the slump spreading to the real estate market as oil companies cut jobs and investment, policy makers said at the time.
Immediate Effects
Economists warned the plan could backfire, exacerbating financial system risks if it fuels near record levels of household indebtedness.
“It was questionable in the first place to want to see a lot of stimulus come through that channel because, as we’ve seen, it does come through in some of the frothier markets,” Chandler said.
Evidence is growing the rate cut had immediate effects. Canadian lenders cut mortgage rates last month to the lowest since at least 2004, according to data compiled by Bloomberg.
Detached house prices in Toronto’s downtown core jumped 8.9% over the past year, pushing the average price up to C$1.04 million, according to the Toronto Real Estate Board. Home sales in Vancouver rose 21%.
The gains came during a month that was the coldest on record in the city, Toronto Real Estate Board president Paul Etherington said in a statement Wednesday.
Two More
“Interest-sensitive spending remains strong, after the Bank threw another log on the fire in January,” Doug Porter, chief economist at Bank of Montreal, said in a note. Chances of another rate cut in April have diminished after the bank’s announcement today, Porter said.
Megan Greene, chief economist at Manulife Asset Management, said the Bank of Canada will still likely cut the overnight lending rate two more times this year. The moves will continue supporting household borrowing and a “frothy” Canadian housing market, she said.
“Even if it is a property bubble, not all bubbles burst, some just fizzle,” Boston-based Greene said at Bloomberg’s Toronto office Wednesday.
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Vancouver has already passed this high water mark, but now it’s Toronto’s turn to experience the $1 million home as the new norm – a property that comes with so much debt even the federal government seems scared of it.
New statistics from the Toronto Real Estate Board released Wednesday show the average price of a detached home in the city reached $1,040,018 in February, the first time prices have crossed over the seven-figure threshold in any housing category.
Those buyers face a three-year-old rule that Ottawa imposed to cool the market, which bans any sort of government backing on homes worth more than $1 million.
As prices rise, some wonder whether insurers like Canada Mortgage and Housing Corp., the Crown corporation that backs bank loans, may have to revisit that threshold.
“Will it encourage insurers to benchmark or index their maximum home price?” asks Rob McLister, the founder of ratespy.com. “Now, a $1 million is an average house so you are basically saying [the government] is not going to insure an average house.”
Mr. McLister says once you get into $1 million plus, your choices of who you can borrow from change dramatically.
“A lot of people think ‘I’ve got a $1 million mortgage. I’m the man, give me the best rate.’ But that’s not necessarily the case,” he says.
In fact, those people are paying even higher rates than those from the banks because their loans have no government backing. If they can’t come up with the minimum downpayment of 20% required by law to borrow from a major bank, they must seek a loan in the subprime market.
Just as in Vancouver, Toronto buyers are now scrambling to come up with the 20% downpayment or $200,000 on a $1 million home, if they want to borrow from a major bank. And, just as happened on the West Coast, Toronto buyers are turning to sub-prime lenders to get them over the hump, facing interest rates of close to 13%.
Yana Papanyan, vice-president of credit and underwriting at First Swiss Mortgage Corp., which is a major player when it come to helping this subprime segment of the market, says in a typical situation, a client might buy a property worth $1 million but only have $100,000 downpayment. First Swiss Mortgage will provide the other $100,000 under a second mortgage starting at 12.99%.
“Clients have to top up to 20% to get a bank to approve. We are filling that gap between what the client has as a downpayment and what the bank will accept,” said Ms. Papanyan. “About 80% of [First Swiss’ mortgages] in Vancouver are high-priced properties.”
First Swiss is not regulated by the federal government; that interest rate is considered competitive based on risk factors including the fact it is a second mortgage behind the bank’s debt.
Why was $1 million chosen anyway?
One positive for these people is they do not end up paying mortgage default insurance, which can be as much as 3.15% of the value of a mortgage, based on current CMHC guidelines.
Benjamin Tal, deputy chief economist with CIBC, says rising prices and the $1 million government threshold is sending more consumers into the subprime market to borrow money. He estimates alternative lenders, who are major beneficiaries of that subprime market, now underwrite 2.2% of all mortgage loans, with the market having grown by 25% over the past year.
“When you say $1 million, people think ‘that’s extremely high expensive properties.’ They are not. This [restriction on loans for homes worth $1 million or more] is leading to less regulated entities entering the market,” said Mr. Tal, adding his data for Ontario shows that people are borrowing just to get the downpayment.
Mr. Tal also wonders whether Ottawa is going to have revisit the rules on whether it is willing to insure homes worth than $1 million.
“It’s a legitimate question. Why was $1 million chosen anyway?,” said Mr. Tal. “This is probably not consistent with the spirit of what they want to do, because the spirit of CMHC is to make housing affordable for young people.”