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“RBC’s affordability measure hasn’t been this bad since 1990.”—RBC Economics
That’s according to RBC’s “Housing Trends and Affordability” report, which is making headlines across the country as we speak.
But if you’re house hunting and terrified you won’t get a mortgage, don’t soil your trousers just yet.
There’s a devil in RBC’s details. It’s the mortgage rates they assume in the study. They’re not exactly realistic.
RBC’s study uses posted 5-year fixed rates, as tracked by the Bank of Canada. When comparing last quarter to 1990, for example, the report assumed that these were the rates borrowers paid:
- Q2 1990: 14.25%
- Q2 2018: 5.27%
Back in 1990, people paid close to posted rate, so no problem there.
The problem is with the rates that RBC assumes people pay today — the actual rates that determine people’s “affordability.” They are much lower than what RBC assumes in its conclusions.
Take the latest data point from June 30, 2018. The real-life average 5-year fixed rate was 3.25% at the time. That makes a huge difference in affordability compared to the 5.27% posted rate that RBC’s report is based on.
Mind you, the government’s “stress test” still requires most borrowers to prove they can afford posted rates like 5.34% (thank the Department of Finance and OSFI for that). So in this sense, posted rates are still relevant.
But if you really wanted to get into the housing market, you could qualify at 5-year fixed rates as low as 3.74% to 4.24% at a non-bank lender. You could even get a 30-year amortization to keep your payments even lower and more easily pass that lender’s non-OSFI-compliant stress test.
Here’s the point of all this. RBC freaked out a lot of people today when it wrote, “The ownership costs to carry a home bought in the second quarter of 2018 would have taken up 53.9% of a typical household’s income (compared to 55.4% in 1990). This is up sharply from 43.2% three years ago.”
But had RBC instead used a more realistic 3.74% rate in Q2 2018, that 53.9% figure would have dropped to 47.3% (we confirmed this directly with RBC).
Long story short, you just can’t take housing headlines at face value. We’re not saying houses are cheap (they’re not, by so many measures). But relative affordability is still materially better than it was 28 years ago.
6 Comments
Mortgage costs (in terms of monthly payments) are only up by about 15% in the last 3 years, despite mortgage interest rates going up by about 50% in that time.
You’ll get slightly higher or lower numbers depending on the terms you compare, but it’s still going to be close. I based my numbers on short-term (1-2yr) fixed rates of 2% vs 3% with a 30-year amortization.
Even if rates increase by another full percentage (something I think is unlikely over the next couple years), monthly payments would only increase by another 13%.
The point about the interest rates correct.
However, the RBC study ALSO assumed a down payment of 25%. That would have been a lot easier in 1990, since the proportion of mortgage payments going to principal were lower (since interest rates were so much higher). It’s harder to save that much now, since principal amounts are so much higher — so down payments are probably lower, and carrying costs higher now than is assumed.
Both factors offset to some degree.
Hi JCM,
Thanks for the comment. It’s good you brought that up.
RBC bases its grim conclusion about Canada’s “eye-watering loss of affordability” entirely on ownership costs as a percentage of median family income. It defines ownership costs as “mortgage payments, utilities, and property taxes” as a percentage of “a typical household’s pre-tax income.”
Apart from noting the 25% assumption, RBC makes not one single comment about down payments in its report.
Certainly 25% down payments are now much bigger ($118,900 today versus $35,400 in 1990). But if one bases an “affordability” analysis on down payment size, one also has to remember that:
* Incomes are bigger too (In Toronto for example, average total household income is about $73,000 today versus $38300 in 1990)
* Family gifts for down payments are far more common
* There are more governmental first-time buyer initiatives
* The RRSP Home Buyers Plan did not exist in 1990 (permitting $25,000 withdrawals for down payments)
* 5% down payment options were not widely available in 1990 (you can get in the average house today for just a $23,800 down payment)
My point was that, when comparing ownership costs to 1990, we must keep in mind that down payments are likely to be lower now in percentage terms (since principal repayment makes up a much larger proportion of mortgage payments). Saving a 25% down payment would have been way easier in 1990.
Apples to apples might be a down payment of 15% today vs. a down payment of 25% in 1990. That would more than offset the issue that you originally identified in your blog.
But an apples to apples comparison is difficult for all of the other reasons that you just mentioned.
I’m not sure what principal repayment has to do with anything. More importantly I don’t know why anyone is talking about down payments when they have nothing to do with RBC’s report.
The average first time buyer puts down 20%! They only need to put down 5%! Figure it out. Down payments aren’t the problem.
YplSaidlt – you don’t get it. If the down payment is much less now then that means the Balance of the mortgage is MUCH BIGGER. If the balance of the mortgage is bigger then the carrying costs will be more. So, not factoring in the bigger avg mortages (because of smaller down payments) might offset the use of posted higher rates. I believe that is the point being made. I think it is a valid point although I personally think the huge “cash only side business” that so many people do is what is contributing to the lower avg income which is actually distorting the avg income numbers to look less then what they are. There is so much money coming into Canada (think Bitcoin) that is never taxed and equally just as much being exchanged for goods that never sees the government coffers or official statistics.