Mortgage rule crackdown spurring move to uninsured lending, IMF warns

Home prices in Canada could be overpriced by as much as 20 per cent in large part because of unexpected growth in uninsured mortgages, the International Monetary Fund warns.

Tightening of CMHC rules have pushed new lending to uninsured mortgages

Canadian house prices have increased by 60 per cent over the past decade, led by gains in cities like Toronto, Vancouver and Calgary.

Ottawa's crackdown on CMHC-insured mortgages is merely pushing people to get uninsured mortgages from other lenders, the International Monetary Fund warns.

In a recent report, the global monetary group repeated its warning about a Canadian housing market it describes as "overvalued." A previous in-depth study released in late 2014 said house prices in Canada are likely between five and 20 per cent higher than they should otherwise be.

But this week's analysis focuses instead on other risks buried beneath the surface of inflated prices. In recent years, Ottawa has moved multiple times to put caps on mortgage terms insured by the government-backed housing agency, the CMHC.

At one time not too long ago it was possible to get a 40-year mortgage with virtually no money down, until Ottawa repeatedly moved the goalposts to get the maximum amortization time down to 25 years, the minimum down payment to five per cent, and a cap of $1 million. If a first-time buyer wants to buy a house worth more than that, they have to get it insured by somebody else. 

IMF economists Hamid Faruqee and Andrea Pescatori say that while those moves have had their desired effect of achieving the "soft landing" that economists have been predicting for prices — if not openly rooting for — there's a flip side to that.

"A possible sign of 'leakage' from tighter financial rules in Canada — which is a general problem that countries can face after tightening such rules — involves the expanding role of uninsured mortgages," the economists say.

Essentially, the IMF is saying that many people who found they couldn't qualify for mortgages under the CMHC's stringent new mortgage rules, instead of deciding to not buy a home, merely sought different types of mortgages. 

Risks remain

On the surface, a borrower with enough cash to put down more than 20 per cent of a house price up front is good news, in that they have more equity to withstand a price correction. But it's not completely free of risks, for the borrower or the system as a whole.

A mortgage that isn't insured by CMHC doesn't mean the system is completely off the hook in the event of default because ultimately, the government backstops all insured mortgages to a certain degree, whether they are insured by CMHC or not. Private insurers like Genworth Canada and Canada Guaranty compete with the CMHC, but they are still 90 per cent backed by taxpayers.

A lot of new business is still happening outside of the CMHC's direct purview. "These now comprise the bulk of mortgage originations," Faruqee and Pescatori said. "If financial risks start rising again, policymakers may need to take further action to tighten rules on these loans."

Even if mortages with more than 20 per cent down don't legally require insurance, many lenders choose to get it anyway, which suggests they're attempting to mitigate their risk.

And an uninsured mortgage is still real debt, which is helping to push Canadian debt levels to an all-time high.

In the past 10 years, average house prices in Canada have increased by 60 per cent, the IMF notes, led by red-hot markets in Toronto, Calgary and Vancouver. The latter was recently ranked second in the world in terms of the lowest affordability globally after Hong Kong.

And never mind a soft landing — some places could be in for something a lot bumpier, they say. "There have been some recent signs that home listings to sales are rising noticeably in oil-rich Alberta, and we will need to keep an eye on the risk of a hard landing," they said.

Some economists say there's ample evidence to suggest that prices can come down, and suddenly. And the growth in uninsured mortgages could just be one more factor for policymakers to pay attention to.

Long term, the IMF economists recommend that Ottawa implement even more rules to further withdraw the government from the mortgage business — as long as it's done slowly so as to not shock the system.

"Over time, Canada would also benefit from reforming the government’s role in mortgage insurance and reducing taxpayer’s exposure to the associated risks. Limiting the federal backstop would increase private sector risk-sharing and can further encourage prudence," they say.

"We need to keep an eye on certain financial risks."