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What Would Happen if the Minimum Down Payment Increased?

The Canadian economy has been debated hotly recently. On one hand, falling oil prices have damaged the economy, driving down our dollar, and impacting jobs. The impact is most pronounced in the west, where the boom had been the most beneficial, and the bust is causing the most problems. On the other hand, house prices in Toronto and Vancouver are being driven higher and higher as detached homes remain in short supply. Rumors have been spreading for years that the bubble is about to burst, and when the Bank of Canada (BoC) cut the overnight lending rate last month, the panic was renewed.

The problem comes from the mismatch between the housing market in those cities and the state of the economy as a whole. When the Bank of Canada interest rate is lowered, variable mortgage rates follow suit (fixed-rate mortgages are based on bond yields and are not directly affected by the BoC). When mortgage rates fall, house prices go up, and the bubble floats a little closer toward the sun. The rate cut was a necessity for cities like Calgary, where the housing market has recovered from January’s drop but still hasn’t reached the high water mark set last summer. But the BoC’s focus is on inflation, not housing, so the boon to real estate in Toronto and Vancouver is seen as a side-effect—one that’s necessary in order to address a bigger issue.

With the BoC’s attempts to bring stability to the economy-at-large causing instability in the housing market, the Financial Post reported the federal government is deliberating whether to do some tinkering of their own to keep the housing market from making a crash landing.

The government hasn’t been afraid to tighten mortgage rules in the past, introducing significant changes just a few years ago in 2012. At that time, the maximum amortization was reduced to 25 years from 30, and CMHC insurance was limited to mortgages on homes purchased for under $1 million—effectively making the minimum down payment 20% for homes worth more.

Today the minimum down payment is 5%, but purchasers putting down less than 20% are required to purchase CMHC insurance at their own expense. Potential rule changes could include increasing the minimum down payment, reducing the maximum amortization period, or lowering the maximum purchase price for high-ratio mortgages. The theory is that forcing borrowers to have bigger stakes in their homes will discourage them from defaulting in a recession, and will soften the blow to the banking system if they do.

But what would happen if the minimum down payment were increased? A Canadian Association of Accredited Mortgage Professionals (CAAMP) report found that 27% of first-time buyers—about 75,000 total—would be unable to afford a home were the minimum down payment increased to 10%. Such an increase in minimum down payments would result in “a reduction of sales large enough to [tip] many local housing markets into downturns,” causing serious consequences for local economies. Fewer buyers would mean fewer new housing starts, and job losses in the construction sector. And buyers saving for a large down payment would be more likely to defer large purchases, taking even more money out of local markets.

The other concern if mortgage rules are tightened is the potential for an increase in shadow lending: mortgage loans offered by private lenders that can demand rates as much as five times higher than those charged by banks. The practice is legal, but comparable to the sub-prime lending that’s blamed for the U.S. crash in 2008. Experts argue that as fewer Canadians qualify for traditional mortgages, they’ll seek out other options that pose a greater risk for the economy.

So will we see the minimum down payment increased? It’s possible, especially considering other mortgage rules are already being tightened up. Earlier in 2015, the CMHC increased premiums for mortgages with loan-to-value ratios of 5%–9.99%. The move signalled they’re prepared to continue backing buyers with minimum down payments, but also that they’re anticipating a higher level of risk. At the same time, lenders are making their own rules tougher for borrowers they deem riskier, such as those who are self-employed. It’s safe to say that if new mortgage rules are introduced, the banks won’t be the ones complaining.

A fair number of homebuyers wouldn’t have much to complain about, either. As we revealed in our Secret Strengths of First-Time Homebuyers Infographic, more than a third of first-time buyers put down 20% or more. In Toronto and Vancouver where house prices are highest, more than half were able to hit the 20% mark.

For now, the minimum down payment stands at 5%, and no changes have been officially announced. Find out how much you can afford and how increasing your down payment affects your mortgage payment using our mortgage affordability calculator.

Flickr: Trudy Veitch

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Overnight Lending Rate in Canada