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The unintended consequences of doubling the minimum down payment on a house

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The unintended consequences of doubling the minimum down payment on a house

The drastic decline in housing sales and forecasts for falling prices over the next year may require governments to tighten credit supply to prevent borrowers from excessive debt obligations in case of job losses, while at the same time trying to stimulate the economy to sustain consumption and avoid job losses. This is easier said than done.

Evan Siddall, chief executive of Canada Mortgage and Housing Corp. (CMHC), expressed serious concerns about Canadians’ increasing debt levels, which are dominated by mortgage debt, in his prepared remarks on Tuesday for the House of Commons Standing Committee on Finance.

Siddall suggested increasing the barriers to take on mortgage debt for first-time homebuyers may provide better safeguards to young borrowers in case they ever had to sell their home at a loss. He suggested “a 10 per cent down payment offers more of a cushion against possible losses” than the current five-per-cent minimum.

The risks identified in Siddall’s statement are certainly real. But what isn’t certain is how much housing prices might decline and how long the job losses will last.

With that in mind, let’s take a look at what is known and think through the likely outcomes of possible policy interventions.

If the future decline in housing prices is a concern, raising the bar for a minimum down payment will exacerbate the fall, rather than arrest it. Doubling the minimum down payment to 10 per cent implies that first-time homebuyers may be forced to buy smaller or cheaper homes, or they may take longer to save the amount needed to purchase a house they like.

If they choose cheaper homes (often smaller-than-hoped units), housing sale activity will slide to lower-priced homes from higher-priced ones. This implies that average prices will further decline. In populous and growing cities, where housing affordability has been a persistent challenge, first-time homebuyers might also have to search for dwellings in the suburbs and beyond where prices are relatively lower than the urban core.

An unintended consequence of a limit on borrowing, therefore, is that it will accelerate growth in the suburbs and smaller towns situated at the urban periphery. An increase in demand for housing on the outskirts will provide additional challenges for cities trying to contain sprawl.

Some buyers might not prefer to compromise on housing size or neighbourhood to comply with the higher threshold for a down payment. They may instead choose to take more time to save the amount they need to buy the house they want, thereby increasing demand for rental units.

COVID-19-related job losses have occurred more frequently in economic sectors where renters dominate, so job losses among renters are likely to moderate rents. But with a freeze on evictions, vacancy rates may not change. Indeed, tighter rental housing markets could be expected if households continue to rent for more extended periods rather than moving to home ownership.

The higher down payment requirement could also affect consumption levels in the short term. Households will have to curtail current discretionary spending to set aside larger amounts for future down payments. At a time when governments are spending hundreds of billions of dollars to sustain consumption levels, changes in policy that may require households to save more by curtailing current consumption will have an opposite effect.

Millennials constitute a large segment of first-time homebuyers. Unlike earlier cohorts, millennials have the good fortune of receiving financial help from their parents and grandparents to purchase homes. Raising the minimum down payment requirement implies that the magnitude of “financial gifts” from parents and others would have to increase. Parents relying on home equity loans may end up with more debt if the down payment requirement is increased for first-time homebuyers.

Siddall in his statement advised that 12 per cent of mortgagors have already requested deferred payments. By September, he expects mortgage arrears to affect one in five borrowers. CMHC also expects housing prices to decline by nine to 18 per cent over the next 12 months. Furthermore, Siddall highlighted the elevated debt levels in Canada, where the gross debt-to-GDP ratio is expected to hit 130 per cent by the third quarter.

Ignoring these grim statistics will be a mistake. However, responding with inadequate measures will be an even bigger mistake. If housing prices are expected to fall by 18 per cent, advising first-time homebuyers to commit more of their savings to a down payment for a value-losing asset seems odd advice. Measures that may reduce consumption might not be the best approach at a time when markets need all the help they can get.

A better way forward is to adopt measures that protect younger households from known and unknown risks while strengthening the economy to avoid sustained job losses.

Murtaza Haider is a professor of Real Estate Management at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached atwww.hmbulletin.com.

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