The Bank of Canada is very correct in saying they won’t raise rates because of the obvious real estate bubble.
The interest rate is a very crude tool which affects many more facets of the economy than just the real estate market.
Right now you can cool down the real estate market by changing the minimum leverage ratios required to purchase – the subsequent decrease in available credit will accomplish this.
Right now the law permits you to take out a mortgage with a 35-year amortization and a 5% down payment. The primary concern is the down payment fraction, and not the amortization rate (although a longer amortization will allow for a larger purchase due to a decreased payment to principal). Essentially you can buy a house on 19:1 “margin”. The most leverage you are legally allowed to use with equities is 30% down.
A simple mathematical example will demonstrate why a 5% down payment requirement is ridiculously low.
With a 5% down payment, you can buy a $400,000 house with a $20,000 down payment, so you would be borrowing $380,000. In the event you couldn’t actually afford the down payment, banks have developed convenient “cash back” mortgages that give you cash up front, but in exchange for a higher rate of interest throughout the mortgage. An example is TD’s “5% cash back mortgage“, where instead of paying a posted 4.24% 5-year regular mortgage rate, you can pay 5.49% for the cash-back option.
Let’s say you purchase this place, and then your house appreciates 5% – so you have $40,000 equity in a $420,000 home. In theory, you can then get a second mortgage on the home for $20,000, cough up another $1,000 from your VISA or Mastercard (since 5% of $420,000 is $21,000) and then buy another $400,000 home with a $380,000 mortgage. If your two homes appreciate another 5%, then you can afford two more $400,000 homes, etc.
One can see how a single person can leverage a lot of money with a 5% down payment requirement. It becomes ridiculously easy in a rising real estate market. Of course, when the real estate market goes down, your ability to borrow money stops, and you then have to face the music when it comes to paying the mortgages (or just calling it a day and default).
With a 10% down payment, it becomes a little more difficult to perform this operation – your fictional $400,000 home requires a $40,000 down payment. Your home will have to appreciate just over 10% in order to be theoretically eligible for a second mortgage that would give a a sufficient down payment to buy another equal-priced place.
The legal minimum down payment before a mortgage should be granted is set to a number higher than what it is currently. Ideally it should be linked to the Canadian government 5-year bond – a lower interest rate should require a higher minimum down payment, while a higher interest rate should require a lower minimum down payment. A more simplistic solution (and much easier to market) is just to increase it to a particular rate. The Canadian government has hinted it may increase.
While in theory people should be left alone to select their preferred debt leverage ratio, it was shown in the USA that the actions of a lot of fiscally irresponsible people (and their banks) caused genuine impact to those that could actually manage their affairs properly – savers in the current environment are basically being punished by the actions of the squanders. As such, it is an easy decision to raise the minimum down payment percentage required to obtain a mortgage.
As a matter of personal finance, people that don’t have at least 20% squirreled up for a down payment should likely not be purchasing a place. This is the minimum amount required to avoid paying any CMHC home mortgage insurance premiums, which is an absolutely unnecessary expense since you are not receiving any benefit out of the insurance (other than the ability to get cheap credit in the first place) – the bank is getting the benefit, while the public is securing it with federal taxpayers’ money.