Financial risk-taking is endangering homeowners

While Hurricane Harvey may appear to have very little to do with the Canadian housing market, journalist Don Pittis said the situation in the Gulf Coast shines a spotlight on the financial risk-taking that is endangering Canadian homeowners.

“Market theory tells us that people who wanted to protect their property from the hurricanes and floods that plague the Gulf Coast should have had insurance,” Pittis said.

However, only about 20% of homeowners in Houston have insurance, according to Robert Hunter, an insurance expert with a US consumer research group.

“All these people taken out in boats, they have a second problem: They have no insurance,” Hunter said.

Just like the homeowners in Houston, those entering the housing market in Canada understand the risks they’re taking on. “If interest rates rise, they know they will have to find more cash to pay their monthly mortgage payments. The alternative is they will lose their homes,” Pittis said.

Right now, the nation’s financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), has taken the lead in trying to contain risks in the housing market. OSFI has proposed banning bundled mortgage loans, a ruling which could take effect later this year.   

Some analysts, including Beata Caranci, TD Bank Group chief economist, have given their stamp of approval to OSFI’s attempts to cool the housing market.

OSFI’s measures are being thwarted

OSFI has to plough through some resistance, as parts of the industry, anxious to keep the boom alive, are working their way around the regulator’s first attempt to discipline the market.

Under the initial rules that kicked in last October, anyone who wanted to borrow more than 80% of the purchase price of a home would have to prove they could afford an increase in borrowing costs of two percentage points (also known as the “stress test”). These borrowers must also buy mortgage insurance that protects their lender if they default.

However, recent evidence suggests that the first stress test is not working. A new report from the Canada Mortgage and Housing Corporation (CMHC) indicates that the number of insured mortgages is declining, following the rule change in October.

“Perhaps people with low down payments are putting off buying a house, but there are signs something else is happening,” Pittis said. “Rather than paying the mortgage insurance and submitting to the stress test, some borrowers are topping up their down payments with loans from unregulated lenders.”

These lenders include mortgage investment corporations that have traditionally offered second mortgages, and some could be from the “bank” of mom and dad.

“In Houston it appears many homeowners were willing to take a risk on losing everything rather than buy expensive insurance,” Pittis said. In Canada, the pressure to buy a dream home in an overheated market means some buyers are willing to squeeze every penny out of their finances without leaving a pad to protect themselves from rising rates.”

“It may be that interest rates will never rise. Before Harvey, perhaps it was reasonable for homeowners to assume Houston would never flood. Now there are fears houses will be abandoned and parts of Houston will never recover." 

Back in Canada, a continued property boom followed by the threat of a sharp fall, as cash-strapped homeowners default on their mortgages, could derail the nation’s economic recovery.

“The free market analysis would say they take the risk, they pay the price. But when disaster strikes, it's not just the individuals who take the risk that suffer,” Pittis said.

More Mortgage Guide