CMHC Rule Changes – June 2020

Traditionally – if the waters are rough, you do whatever you can to not rock the boat. CMHC today however has rocked the boat.

The housing market has weakened over the last few months, due to the pandemic, but Canada’s largest default insurer is making it tougher for people to get a mortgage, at least for borrowers with higher debt loads, lower credit scores and borrowed down payments, that have to put less than 20% down and must acquire default insurance.

The official announcement is linked here. The changes take effect July 1, 2020

Below is a series of updates collected throughout the course of yesterday (June 4, 2020) afternoon. In descending order:

All times Pacific

7:25 p.m. (Final) Update

• CMHC’s new debt-ratio policy will cut the purchasing power for home buyers between 10-12%. Someone earning $60,000 with no other debt and 5% down could afford approximately 10.9% less home under CMHC’s new rules.
• In the last few weeks we have seen the minimum stress test rate drop down to 4.94% where it lies today.
• These changes, acts like jacking up the stress test to 6.30%!
• In a report this evening by RBC Capital Markets, Genworth and Canada Guaranty reportedly indicated that the choice to adopt any/all of CMHC’s changes is theirs. CMHC’s policies were not an industry-wide mandate by the Department of Finance.
• Insured borrowers currently account for roughly 20% of new mortgages. A top insurer executive once told stated that credit score, loan-to-value and geography all predict defaults on these loans better than debt ratios.
• 20% of down payment funds from first-time buyers came from borrowed sources, according to a Mortgage Professionals Canada survey in February of this year.
• Only 2% of down payments for CMHC-insured borrowers with loan-to-values above 90% were from “non-traditional sources” like unsecured credit and loans. Meaning that most of the time, if people were borrowing the down payment, they were doing so to put more than 10% down.
• Analysts are saying that these rule changes could cost CMHC upwards of 20% of their new business.
• CMHC has been the market leader for default insurance for decades, and this could mean that they lose market share to the other insurers.
• Assuming that Canada Guaranty and Genworth do not follow suit, because borrowers in Greater Toronto and Vancouver generally have higher debt ratios⁠—these borrowers with higher debt ratios and less than 20% down payments would choose Canada Guaranty or Genworth by default, since they’re the only games left in town.
• This may lead to CMHC to shifting more of its business into less urban and less liquid real estate markets.
• What is interesting to note is that historically, liquidity is key if home values dive, and CMHC would be treading into less liquid territories.
• Today’s announcement is just the latest in a long series of measures that have reduced CMHC’s business.
• It appears that they are on a mission to dismantle themselves. And if this is the case, It makes one wonder—from a taxpayer standpoint—if Ottawa should have sold the crown corporation’s commercial loan insurance business before this process began.

4:51 p.m. Update

• From CMHC: “Starting July 1, 2020, borrowers must pay the down payment from their own resources. These eligible traditional sources of down payment may include savings, the sale of a property, non-repayable financial gift from a relative, funds borrowed against their liquid financial assets, funds borrowed against their real property, or a government grant.”
• From Paul Taylor, CEO of Mortgage Professionals Canada: “As a custodian of taxpayer-contingent liability for their $500 billion portfolio, I understand CMHC’s need to continuously review risk acceptance criteria. However, I think the timing for the introduction of these restrictions is poor, especially given the Federal government itself is pouring billions of dollars into the economy to keep it afloat. These measures are procyclical, and will potentially exacerbate the 9-18% house price reductions CMHC has already warned of, by disqualifying many would-be borrowers from entering the market. Fortunately, I understand the private mortgage insurers are not likely to follow CMHC’s changes in lockstep, so the differentiation in risk appetite between them may reduce the contractionary economic impact, and see a shift in market share away from CMHC to the private insurers.”
• If Genworth and Canada Guaranty don’t lower their debt ratio limits, the credit score change may be the story here. There’s a chance all three insurers could lift their minimum scores to 680 (for at least one borrower on the mortgage application). If that happens, these homebuyers are out of luck if they don’t have 20% down and don’t want to pay crazy private lender rates.

2:43 p.m. Update

• CMHC statements:
  • “Our forecasting suggests the ratio of household debt to disposable income will climb from 176% in late 2019 to well over 200% through 2021. These measures are intended to curtail excess demand and household indebtedness.”
  • “Job losses, business closures and a drop in immigration are adversely impacting Canada’s housing markets, which stand to see a 9% to 18% decrease in house prices over the next 12 months.” (It seems CMHC’s CEO, Evan Siddall, knew these policy changes were coming when CMHC made this prediction a few weeks back.)
• Only 5.9% of CMHC-insured mortgages in the first quarter had credit scores below 680.
• Housing analyst Will Dunning posed a very good question “How does changing the maximum GDS/TDS mitigate risk related to job loss or income reduction?”
• The following can no longer be used for down payments at CMHC: unsecured personal loans, unsecured lines of credit and credit cards. (Yes, believe it or not, some people do/did buy homes and put some of their down payment on plastic.)
• Private insurers will likely announce their stance next week. There’s a better chance of them matching the 680 credit score minimum—and possibly the new down payment restrictions—than the debt ratio tightening, only time will tell.
• CMHC changes apply to all default insurance it sells (high-ratio and low-ratio).
• “They do not apply to [Genworth or Canada Guaranty] insured mortgages that will be securitized in NHA MBS and Canada Mortgage Bonds,” said a CMHC spokesperson. That means mortgage finance companies will still have a way to fund non-CMHC-compliant mortgages, which in turn means consumers will still be able to get those mortgages cost-effectively.
• That said, we would not be surprised in the least if rate premiums and/or default insurance premiums were higher for borrowers with debt ratios above CMHC’s new limits.
• Will CMHC drop its insurance premiums now that its loan book is getting less risky, unlikely, since it was not even mentioned.

1:30 p.m. Update

• Just in. CMHC’s official announcement.
• “COVID-19 has exposed long-standing vulnerabilities in our financial markets, and we must act now to protect the economic futures of Canadians,” said Evan Siddall, CMHC’s President and CEO. “These actions will protect home buyers, reduce government and taxpayer risk and support the stability of housing markets while curtailing excessive demand and unsustainable house price growth.”
• CMHC adds: “These decisions are within CMHC’s authorities under the National Housing Act and are in anticipation of potential house price adjustment.”
• Critics of the move will argue:
  • There’s a misconception that borrowers with high debt ratios are significantly more risky. Insurers don’t approve many such borrowers, even if they fit within the official guidelines. Insurers aren’t stupid. They insure borrowers who are highly likely to pay on time, based on years of insurer data and experience.
  • A large proportion of high-debt-ratio borrowers are professionals in liquid housing markets with high incomes and temporarily high debt loads, many with big student loans.
• This move will make the stress test tougher, but if the government follows through on easing its minimum qualifying rate (i.e., the benchmark rate), that could offset CMHC’s announcement to a large degree. The benchmark rate change was scheduled for April but postponed indefinitely due to COVID.
• There is no change to down payment rules. There was fear of down payments rising to 10% minimum a few weeks ago after CMHC’s CEO expressed opinions on it. But that could have all-out nuked the market. Today’s announcement is just a big cannonball…unless these changes are more widely adopted at some point.

12:07 p.m. Update

• Reliable sources tell us there’s a high probability private insurers will not match CMHC’s more conservative debt ratios. The privates would still serve most (not all) of these “Non-CMHC Compliant” applications, but they’d underwrite them more carefully to avoid an “adverse selection” of borrowers.
• That limits the overall borrower impact from this news, unless CMHC applies its rules to all securitized insured mortgages, which would limit choices and hike costs for insured borrowers who don’t fit CMHC’s new guidelines.
• With the government spending hundreds of billions on economic life support, lenders we’ve spoken to are incredulous that CMHC (a crown corporation) would tighten rules now.
• It’s “hard to believe they would make a move like this in the middle of a pandemic,” one lender head said. And on a side note, lenders are ticked that they just found out about this yesterday.

11:21 a.m. Update

From what we hear (this is unconfirmed), effective July 1, the following may apply to CMHC-insured mortgages:

• Maximum gross debt service (GDS) ratio drops from 39 to 35
• Maximum total debt service (TDS) ratio drops from 44 to 42
• ​Minimum credit score rises from 600 to 680 (for at least one borrower)
• Borrowed down payments will be banned

Official announcement is expected later today.

What Will This Do to the Housing Market?

61% of first-time buyers buy with less than 20% down (i.e., get an insured mortgage), according to data from Will Dunning and Mortgage Professionals Canada.

How they’re affected and the fallout from CMHC’s move depends on whether:

1. Private insurers impose the same rules
   • This would limit all options for borrowers who don’t have 20%+ for a down payment and don’t qualify with CMHC
2. Big 6 banks, which dominate prime-mortgage lending in Canada, eventually harmonize their low-ratio mortgage guidelines with these new insured mortgage guidelines from CMHC
   • If so, the change could have a broader impact on borrowers
3. CMHC will impose its changes on all insured mortgages that are securitized (i.e., sold to investors). CMHC runs Canada’s mortgage securitization business, with direction from the Department of Finance.

All three of these things are unlikely near-term, which means the housing impact may be less than many fear. Albeit, CMHC’s pro-cyclical rule tightening is sure as heck not helpful to market psychology. It’s no secret that homebuyer and homeseller confidence significantly influence home prices.

Updates to follow…..

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