CMHC role

CMHC insures mortgages issued by financial institutions when the buyer provides a down payment of less than 20%.

The government organization believes the pandemic is adding more risk to the Canadian housing market. The view makes sense as high unemployment and a reduction in immigration hurt home demand.

CMHC anticipates a 9-18% decrease in house prices over the next 12 months, which means that new buyers with minimum initial equity in the home are at risk of owing more than the house is worth.

According to the latest update by the Canadian Bankers Association, Canada’s banks have provided payment deferrals on 15% of total mortgages in their portfolios. The Mortgage Professionals Canada 2019 year-end survey estimates total mortgage and HELOC financing on owner-occupied primary residences is $1.45 trillion.

A wave of mortgage defaults at the end of the current deferral period could trigger a flood of listings. Given the potential risk, CMHC announced changes to the rules for new applications for homeowner transactional and portfolio mortgage insurance.

CMHC rule changes

Starting July 1, CMHC is making it more difficult for high-risk borrowers to buy a house. The minimum credit score is being raised from 600 to 680 for at least one borrower. The maximum total debt service ratio is dropping to 42 from 44 and the gross debt service ratio must be 35 or lower, instead of 39. This is the share of the borrower’s income that would go toward paying all housing costs.

In addition, CMHC is targeting situations where people borrow money to make their down payment. Unsecured personal loans and unsecured lines of credit won’t be acceptable as equity for insurance purposes.

According to the Mortgage Professionals of Canada survey, 49% of first-time home buyers had down payments of less than 20% from 2015-2019. Loans from a financial institution represented 13% of total down payment funds. Loans from family members represented 7%, loans from employers accounted for 1%.

Results

CMHC says the moves are designed to “protect home buyers, reduce government and taxpayer risk and support the stability of the housing markets while curtailing excessive demand and unsustainable house price growth.”

Critics of the move suggest the timing of the tightening could put more pressure on the economy. Cutting a large chunk of potential new buyers out of the market could reduce overall sales and hit all the related businesses that benefit from robust real estate activity.

Impact on banks

The Canadian banks set aside significant funds for potential defaults when they reported fiscal Q2 results. The goal of CMHC might be to ensure the situation doesn’t get worse.

The new rules will limit the potential pool of new mortgage customers for the banks. However, most of the big banks are already being very cautious regarding new loans.

The CMHC restrictions will likely have a larger impact on the companies that provide mortgages to people who can’t get the loans from the banks.

The bottom line

The CMHC rule changes shouldn’t be a significant issue for investors in the large banks. Stock prices already reflect the housing outlook and the dividends should be safe. The announcement just reinforces the potential risks that exist.

A successful reopening of the economy is the most important hurdle. If we get a V-shaped recovery, the housing market should be fine and the banks will benefit.