What’s wrong with protecting people from financial default? What's wrong with cooling housing prices?
This is a true story from just before the recession earlier this century. It helps illustrate why Canada’s mortgage stress test makes so much sense.
A newly-married and very well-heeled couple wanted two homes – one in California and one in British Columbia.
Getting financing for the California home was no problem. All the funding was readily available and came surrounded by offers of even more money, perhaps to pay for furnishings or a new car.
Financing the B.C. home was different. Even though the couple had more than comfortable incomes and assets, they were asked to provide income tax returns. There was definitely a ceiling on the size of the mortgage they would be granted.
The difference between these two lending approaches became clear in the recession that followed.
The U.S. approach was to offer as much credit as possible to just about any homebuyer, in the misguided belief that once you were a homeowner, you automatically became a productive, stable, taxpaying citizen.
Alas, lending more money than people were able to pay back for homes they couldn’t afford had the opposite effect. That was particularly so in states where the only recourse for those holding the mortgage is to seize the home and not other assets or income. The resulting dramatic drop in home prices was a major trigger in the recession that followed.
Canada, with its much more rigorous and fussy lending standards, didn’t see a collapse in housing prices. So we managed to avoid the major impact of the Great Recession, which hurt so many other countries so badly. We were a positive example to the world.
We should not forget this lesson now.
As the Bank of Canada keeps reminding us, too much debt isn’t good for the economy or consumers. Mortgage debt is the biggest component of consumer debt and, thus, most likely to become unmanageable and lead to trouble.
Interest rates are near historic lows. Any increase could push many families with mortgages into serious trouble. And it’s not just younger people who are vulnerable. Many Canadians entering their lower-income retirement years still have mortgages.
Very wisely, the federal banking authorities have decided that those granted mortgages shouldn’t be so close to a financial edge that they could not endure an increase in interest rates. So, since Jan. 1, 20118, we have federal guidelines that lay out the mortgage stress test.
From the screams that followed the implementation of the stress test, you might expect disaster.
The real effects are less dramatic. Yes, some people can’t get as large a mortgage as they might want – or any mortgage in some cases. This reduces the demand for homes, brings down home sales and house prices.
But most people think lower home prices aren’t a bad thing.
And people who do get mortgages should be more secure in their homes and less likely to default.
Who opposes the stress test?
In the short run, some may be upset at not being allowed to get into debt over their heads. However, Canadians are adaptable and most will find ways to keep themselves housed.
The real estate industry is also not happy about fewer sales and lower prices. But they’ve been riding high on the overheated housing market for a long time and should be able to make it through a cooler period.
Canadian banks make a good portion of their income from mortgage lending. The stress test reduces this source of income and may affect their share prices. Nevertheless, in an uncertain world, Canadian banks, with or without the stress test and even with slightly reduced profits, remain among the most secure investment vehicles.
One real issue remains.
Some high-risk borrowers denied mortgage credit will resort to less scrupulous, high-interest lenders. That puts their financial security at great risk.
They’re like the roofer who didn’t want to be limited by safety equipment as he worked on the top of a house. When finally convinced to hook into the gear that could save his life, he asked: “Is it okay if I unhook this when I get to the edge of the roof, because it really gets in the way then?”
Financially or otherwise, in Canada we really try to protect people from falling off the edge.
Troy Media columnist Roslyn Kunin is a consulting economist and speaker.
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