Many of Canada’s Peak Real Estate Buyers Might Already Be Underwater

Many of Canada’s Peak Real Estate Buyers Might Already Be Underwater

Canadian real estate prices are falling at one of the fastest rates ever, averaging nearly $1,000 per day last month. This has a number of lenders revising their forecasts for home prices much lower, bringing up concerns about mortgage borrowers. The good news is most people in Canada don’t have a mortgage, and even more didn’t buy at the peak. The bad news is the typical home buyer who used a government-insured, high ratio mortgage and left the minimum downpayment, might already be underwater.

Most Canadian Home Buyers Will See Little To No Impact

Today we’re going to be running through the numbers for Canadian home buyers that went with the minimum downpayment. More specifically, we’d like to get an idea of how many would have to pay to sell last month, had they bought at the March peak. The CMCH, Canada’s state-backed mortgage insurer, has custody of this data but apparently denied mortgage veteran and columnist Rob McLister the data. We thought we’d do some napkin math to see if it’s worth pursuing any further.   

Personally, I also feel that we should explain what these numbers aren’t. As a general rule, we don’t have an opinion on whether you should buy or sell. It doesn’t matter to us, and we hope you’re happy either way. Looking at today’s numbers might be scary to a recent buyer though. These buyers should carefully consider the impact of holding or selling, and run their specific numbers with a trusted expert. Taking a loss due to a calculated risk is one thing, but panic decisions are almost always bad (on the way up or down). 

The vast majority of homebuyers buy a home to live in, so short- or medium-term price consequences mean little. Ask your parents (or grandparents, jeez I’m old) how the 90s crash worked out. If they were a recent buyer during that period, they’d probably tell you they were very stressed at the time, but it was ultimately a nothing burger. They weren’t speculators that needed to worry about cash flow and short-term costs, their homes just worked in the background for them. Speculators and investors are another story.

Every purchase and sale is individual to the buyer and seller, and they should make decisions specific to them. Find someone trusted who will run numbers with you, and help determine your risk tolerance and timeline. Bonus points for finding someone who does opportunity cost calculations of using capital in other ways. 

Now, on with the show. 

Canada’s Peak Home Buyers With Minimum Down Payments Are Barely Above Water

Canada’s peak buyers that snatched a home at the March peak with a minimum downpayment aren’t having fun. CREA puts the price of a benchmark, or typical, home at $868,100 in March 2022. It was reported at $809,700 in June, down 6.7% (-$58,400) lower than peak. It’s a hefty decline, especially considering how long it would take the average household to save $58,000. 

The minimum downpayment using a high-ratio mortgage backed by an org like the CMHC was about 7.1%. That would leave March peak buyers with a mortgage loan of $806,300, about $3,400 higher than June’s price. An average price decline of 4 days in June would be all it needs to sink that number into the negative. Considering a buyer in March would have just moved in by June, that’s probably not a great feeling.

Canada’ Peak Buyers Spent More On A Home Than It’s Worth When Including Insurance Costs

But wait, there’s more! Any Realtor worth their salt will tell you home buyers and sellers often underestimate costs. This is especially true when it comes to the cost of buying and selling real estate. Things like land transfers, pre-paids, commissions, appraisal, mortgage penalties, taxes, etc. all add up. Since those fees vary by market, let’s just look at the cost of mortgage insurance for now.

Mortgage insurance, mandatory for a high-ratio mortgage would have been about $32,200 plus taxes. The mortgage loan and cost of insurance adds up to $838,500, already higher than the price of a home last month. Had you sold last month, your down payment would be gone and you’d have paid around $28,800 for the three month trip… that once again, you probably haven’t even spent much time in.

Canada’s Typical Peak Buyer Would Have To Pay To Sell

If you’re not a Realtor, you’ll also have to add in the seller’s commission. It might sound odd that we’d specify that, but if you’re a reader in Toronto, the odds of you being a Realtor is higher than being a public school teacher. A seller would have to pony up roughly $37,100 if the home sold at the June benchmark price. That assumes it was a 5% commission, which is typical for most markets across Canada and the US. BC is a notable exception where it’s actually lower — probably the only thing cheaper in BC. 

Not All Markets Are Equal, But 1 In 6 Major Indexes Have High Ratio Borrowers That Might Be Underwater

We know, you only counted analysis of the national market on the way up — it’s not a real market on the way down. Correct, national market analysis makes sense for analysts and people looking at the impact at the national scale. This is important for assessing trends related to the macro environment, such as interest rates and credit. Most sales are concentrated in just a few markets, but let’s look at the numbers across the country anyway. 

A little under 1 in 6 major CREA HPI indexes that represent major markets would be lower in June. High-ratio mortgage borrowers with a minimum downpayment in March would have borrowed more than June’s prices. Likely surprising no one, those markets are almost all in Southern Ontario — Niagara, Kingston, Brantford, Cambridge, London, and Kitchener-Waterloo. The one exception was Chilliwack, in BC. 

Adding the cost of mortgage insurance, over a quarter (27%) would have paid more for a mortgage and insurance than the sale price in June. Once again, most of the markets added to the list are in Southern Ontario, or around Ottawa. An exception introduced includes Winnipeg, which didn’t see much of a boom over the past two years but is feeling the slowdown.

Canadian Real Estate Markets Where Peak Buyers Are Likely Underwater

The price of a typical home across Canada in June 2022, in contrast to the amount of debt (principal + insurance cost) a high-ratio insured mortgage borrower who bought at peak would have. Only markets where peak borrower debt was larger than the price of a home in June, are shown.

*Benchmark condo apartment used instead of composite due to insured mortgage threshold.

Source: CREA; Better Dwelling.

Peak Condo Buyers In A Lot of Canada’s Most Expensive Markets Would Have To Pay To Sell

Mortgage insurance can’t be used for homes over $1 million, which excludes 9 key real estate markets in March. For those markets insured buyers are largely restricted to condo apartments instead of the composite. So let’s run the numbers on that peak. 

Two of those nine markets would have borrowed mortgages larger than the benchmark price in June. They were Oakville and Mississauga, both in the Greater Toronto Area (GTA). 

Adding the cost of mortgage insurance puts mortgage costs in 6 out of the 9 markets greater than June prices. That throws Toronto, Barrie, and Guelph into the mix. The exceptions are Vancouver, Lower Mainland, BC, and Hamliton. Hamilton condo prices peaked one month later in April, and one more month like June would put the benchmark below the size borrowed. Vancouver condo prices peaked in May, and would need about 4 months of June’s price drops to turn negative. 

Canadian Real Estate Markets Where Peak Buyers Might Be Underwater Soon

The price of a typical home across Canada in June 2022, in contrast to the amount of debt (principal + insurance cost) a high-ratio insured mortgage borrower who bought at peak would have. Only markets where peak borrower debt was smaller than the price of a home in June are shown.

Source: CREA; Better Dwelling.

Canadian Real Estate Prices Expected To Fall Further, But This Isn’t As Bad As It Sounds

If banks like RBC and BMO are right and prices take a historic drop, it might bring up even more concerns. What if underwater mortgage borrowers need to renew and are forced to increase their down payment before renewing? It’s important to remember banks don’t want your home, they want regular payments to continue to carry the costs of the mortgage you borrowed from them. 

Reading between the lines, the banking industry has indicated they expect this sort of event to occur at some point. Last year, BMO’s chief risk officer (CRO) implied they were preparing to deal with “exaggerated” home equity. The bubble prices inflated home equity making the loan-to-value (LTV) ratio unreliable, so they placed greater focus on the borrower’s ability to repay the loan regardless. It involved more manual verifications to make sure they could continue paying even in a risk event. 

Canada’s bank regulator has also hinted the rules are intentionally written to not force people out. Guideline B-20 “stress tests” require testing LTV ratios. However, OSFI previously explained to us that an LTV check may not be at the time of renewal, necessarily. The implication here is it’s more of an issue of discretion and a tool to manage their risk with bad borrowers. It’s hard to see a lender applying too much pressure. After the US crash, lenders allowed homeowners to continue paying their negative equity mortgages up to a decade later. So generous, I know. 

No guarantees, and it’s worth noting the new head of OSFI called Canada’s real estate a “speculative fever,” as a warning. However, it’s not going to be a collapse-the-economy style event. At the same time, we’re not exactly looking at an “it always goes up” environment either, and people should be paying close attention to their risk profile. And if you’re a recent buyer, hopefully you really like your place since you might be stuck there for a while. That was one of the warnings people ignored from one of the country’s Big Six banks.