The big stick

Just 16 more sleeps now until B20 lands. What the new stress test will do to residential housing is a giant topic at the moment. Will it tank the market, just stall it, or end up being as useless as the last stress test was for high-ratio borrowers?

To summarize: starting in a couple of weeks banks must ensure all borrowers can service their loans if interest rates shoot higher. To do so, people applying for mortgages will have to prove (with their income) they can make the payments at the current market rate + 2%. So, come January it’ll be as if mortgages had just popped over the 5% mark. Compared to the 2% loans available last winter, that’s an extreme change.

The federal bank regulator is doing this, largely, because of the Bank of Mom. After a similar test was brought in for kids with less than 20% to put down, CMHC-insured loan volumes crashed more than 40%. Unable to pass that test, the newbie buyers with small down payments were borrowing money from parents (and other unsavoury sources) in order to escape it. As a result the banks found their uninsured mortgages  were exploding higher, but that a lot of borrowers were actually high-risk – leaving them more exposed.

So the regulator said enough, already. Everybody will be tested, regardless of the heft of the down payment – no exceptions. And here we are. Also notable is that anyone with an existing mortgage who, after January 1st, wants to change lenders must also go through the stress test process. Astonishingly, that amounts to 2.7 million households who will be locked into their existing lenders.

So what happens now?

The mortgage industry says about 18% of overall credit will be reduced. More than 100,000 buyers won’t get the financing they want. Roughly half of those will end up buying nothing.

The real estate industry (CREA) says this will reduce overall sales next year by 5%, that prices will come down, 12,000 jobs in the industry will be lost and the economy will be impacted with a reduction of $1 billion in activity.

The Bank of Canada estimates about 10% of home buyers will be affected because that’s how many in 2016 would not have qualified under the new rules. This would represent some 36,000 lost sales, or $15 billion worth of borrowing.

Veteran mortgage guy and RateSpy founder Rob McLister says one in six borrowers will be caught in the stress test process next year, but that they “won’t just give up.” In fact, determined to buy real estate despite the odds, they’ll make some very bad choices. This will include taking loans with 30-year amortizations (more interest), dealing with a non-regulated lender (more interest), not shopping for a better rate when they renew (more interest) or dealing with a credit union (probably more interest).

And he makes this prediction: “Make no mistake, some home prices may drop for a while as B-20 trims demand (temporarily lowering debt ratios). But prices will surge to new records once again, leaving indebted borrowers in a worse—less flexible—position than today.”

If this is true (beats me) then B20 will make life as we know it more pooched. Real estate sales and prices will continue to rise, hurting affordability. People struggling to buy some will borrow more and save/invest less. Consumers will be shut out of making choices that actually improve their financial situation. The banks and CUs will make out like bandits. The unregulated shadow banking business will flourish as never before. Our debt gasbag will inflate further until, one day, we blow up.

And speaking of that, we just hit a new high of 171% in debt to disposable income, which exceeds the worst level those irresponsible Americans achieved just before that real estate market imploded. Now households owe $2.11 trillion, which is bigger than the entire economy (that takes some effort). Most of it is mortgages, of course. To date we have financed about $1.4 trillion against real estate, and the pile continues to grow larger.

Naturally, as interest rates increase (three more Fed hikes in 2018 and at least two in Canada) the cost of debt servicing increases. Disposable income drops. The economy is affected. Last year, for the first time in eight years, family net worth fell. And people still expect housing prices to increase?

Logic tells us that when rates went down and credit flowed, house lust flourished and property values rose. Now central banks are tightening and the regulators are freaking. We’re at unheard-of levels of borrowing, and crap houses cost $1 million. B20 is the big stick intended to beat the natives into submission. If this fails, round up the horses.

The bite

She bought the property, firm, plunking down a $50,000 deposit for 46 Raleigh Crescent, in the troubled GTA exurb of Markham. Then, a change of heart. In the midst of a declining market the buyer decided the deal wasn’t right. Her lawyer sent notice it was being repudiated – a legal term indicating the contract was unenforceable since one party was walking away.

But, of course, you can never walk. There are always consequences, the very least of which is surrendering your deposit.

So she did something clever, employing an arcane tactic that’s been gaining currency at a time of disintegrating deals. Her lawyer registered a ‘caution’ against the title of the Raleigh house, attempting a sort of blackmail against the owner. Unless the deposit is returned, her lawyer said, the caution will remain, rendering the property unsaleable. (A caution is a legal warning that someone other than the owner has an interest in the property. With one in place, you can’t sell or finance.)

Enter Albert Frank. He’s a hardened litigation lawyer with three decades of experience in smacking around his clients’ enemies. Hired by the owners, he went to battle in a case that intrigued him.

“I’d never seen this before,” he told me on Thursday. “I searched case law back for the last hundred years and did not come across any instance where someone used a caution over the issue of a deposit. It was just bizarre. Here’s a buyer who repudiated the deal, who‘s not claiming any interest in the property, and yet filed an instrument against the title. Obviously it was designed only to hold the property to ransom.”

So Al went to court to get the thing quashed. “I was startled when I was there and talking to other lawyers that at least two of them were facing the same thing. I guess it’s the current new thing to leverage the return of a deposit.”

So what happened in the Ontario Superior Court of Justice?

“The judge was very unimpressed.” You bet. Not only did he rule that the caution had to be removed, but gave the homeowners costs of $10,000 to cover the cost of hiring a sharp dude like Albert to get the job done. Meanwhile Century 21 Leading Edge Realty was ordered to fork over the fifty grand in their trust account (they would not do so without a mutual releases signed by buyer and seller) to the jilted seller. Now they can close the deal with a new buyer, and still go after the old one for damages.

At least that’s the theory.

You might recall the blog dog who sold his suburban house for $2.25 million in early April, only to have the buyers walk days later as the GTA real estate market started to fall apart. He sued, they ignored it. He eventually sold for $400,000 less than the original amount, and filed for damages. They ignored it. His lawyer secured a court date. They said they were busy. And now the whole thing is slated to go to trial – maybe – in May or June. Meanwhile the owners have racked up a sizeable legal bill and feel the justice system is a sham. To make matters worse, the deadbeat buyers are suing the owners, alleging they took too long to get their place back on the market.

Isn’t real estate fun?

If you’re selling a house – with more market declines ahead thanks to the new stress test – make damn sure the deal is solid. No long close. A mother of a deposit (ask for 10%). No buyer visits prior to closing. Deposit held in your lawyer’s trust account, not that of the listing broker. No condition on the buyer finding ‘satisfactory’ financing. And a clause giving you a day or two for legal approval of the offer.

Also do something radical – find out who the buyer is before you enter into a contract with them. Job? Circumstances? Background? Can they afford it? After all, you’d never rent your cheapo condo to someone without a credit application, references, credit check and income/employment verification. Why sell a $1.5 million house to a stranger and make huge life changes based on a closing months away that may never happen?

Say, did you hear household indebtedness just hit a new all-time high? And that people are borrowing money on their HELOCs at 3.7% to lend out as down payments to desperate moisters trying to beat the stress test, at 10.5%?

If you like disaster movies, you’ll probably love 2018.