Pre-sale buyers need to understand how the new mortgage rules coming into play on April19th can greatly affect them. If you are waiting to take possession of your new unit, make sure you find out as soon as possible whether the new mortgage rules will hinder your ability to close.
The following is from an article written by Wesley J. McMillan, an associate with Harper Grey LLP in Vancouver. He has significant experience helping pre-sale purchasers and in many other types of real estate, small business and construction litigation. Reprinted with permission (Thank-you again, Wesley!)
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How do the new rules affect pre-sales?
A purchaser may have signed a pre-sale contract in 2007 expecting to complete the sale in 2010. The new mortgage rules could throw a significant wrench in those plans.
1. Tougher mortgage qualification standards
The requirement to qualify for the conservative five-year, fixed-rate mortgage makes it more difficult for many purchasers to complete on their pre-sale contracts. As the pre-sale purchase is not subject to a mortgage pre-approval, purchasers who are unable to obtain financing will either:
a. find a way to assign their pre-sale contract to someone else (usually at a fee payable to the developer);
b. find a lawful way to cancel or rescind the pre-sale contract and have the deposit returned; or
c. lose the deposit and walk away from the deal.
In a declining market as was recently experienced in BC, the risks to purchasers increase. Purchasers who fail to complete may face a lawsuit for additional losses. The purchase price is locked in when the pre-sale contract is signed. If the real estate market declines and the purchaser fails to complete when the unit is ready, the developer will sell the unit for less than the price set out in the pre-sale contract.
If the developer ultimately sells the unit for an amount that does not equal:
a) the re-sale price plus; b) the deposit already paid by the original purchaser, the developer may sue for the difference.
In 2009, some condos were re-sold for 40% less than the agreed upon purchase price. If the original purchaser paid a 15% deposit, the developer still loses 25% of the money it expected to receive. Many developers have sued the original purchasers for that 25% difference and the deposit paid. Purchasers who have already lost significant deposits are being asked to pay even more.
2. Increased down payment for investment properties
Perhaps the most worrisome rule change for pre-sale purchasers is the quadrupling of the minimum down payment from 5% to 20% for non owner-occupied properties. Pre-sales have been a popular form of investment since the 1990’s. In addition to gains in equity, completed condos can serve as a valuable income-generating asset. Minister Flaherty refers to those who purchase pre-sales as an investment as ‘speculators’. They are more accurately called investors.
Most investors enter into pre-sale agreements with the belief that their investment will increase in value. They will pay a deposit to the developer (typically 10% – 15% of the purchase price) and, if all goes well, the unit will be worth more at closing. Obtaining a mortgage for the balance of the purchase price (including 5% GST) will be fairly easy.
If the value of the unit does not change, the new rules will require the purchaser to obtain a further 5% – 10% (on top of their original 10% – 15% deposit), plus 5% GST to qualify for a mortgage. On a $500,000 condo, this would mean obtaining $50,000 – $75,000 cash on as little as 10 days’ notice, plus still having to qualify for the mortgage.
Of course, things don’t always go as planned. Under the old rules many purchasers – both investors and those purchasing a home – have been confronted with a situation in which the value of the unit is now equal to or less than the price they agreed to pay.
If the unit has dropped significantly in value, it may be worth less than the purchase price minus the deposit. From a bank’s perspective, there will have been no down payment even though the purchaser paid a 15% deposit to the developer. The purchasers would be forced to come up with additional cash to meet the current minimum 5% down payment.
This is a difficult proposition for many. When the minimum down payment quadruples, it will be impossible. Using the example above, the purchaser would be required to come up with at least $100,000 cash at closing in addition to qualifying for a mortgage.
An illustration:
No change in the market or mortgage rules:
Original pre-sale purchase price $500,000
Minus 15% deposit paid to developer – $75,000
GST on purchase price $25,000
Amount owing $450,000
Market value: $500,000
Amount bank will finance (95% of market value plus GST) $498,750
Amount of cash purchaser will need at closing $ 0
No change in the market, new mortgage rules:
Original pre-sale purchase price $500,000
Minus 15% deposit paid to developer – $75,000
GST on purchase price $ 25,000
Amount owing $450,000
Market value $500,000
Amount bank will finance (80% of market value plus GST) $420,000
Amount of cash purchaser needs at closing $ 30,000
15% decline in market, old mortgage rules:
Original pre-sale purchase price $500,000
Minus 15% deposit paid to developer – $75,000
GST on purchase price $ 25,000
Amount owing $450,000
Market value: $425,000
Amount bank will finance (95% of market value plus GST) $423,938
Cash purchaser needs at closing $ 26,062
15% decline in market, new mortgage rules:
Original pre-sale purchase price $500,000
Minus 15% deposit paid to developer – $75,000
GST on purchase price $ 25,000
Amount owing $450,000
Market value $425,000
Amount bank will finance (80% of market value + GST) $357,000
Cash purchaser needs at closing $ 93,000
Under the old mortgage rules, if an investor paid a 15% deposit on a $500,000 pre-sale and the market dropped by 15%, the investor would need approximately $26,000 cash at closing. Under the new rules and in the same circumstances, the investor would need $93,000 cash at closing before being considered for a mortgage.
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The above is an excerpt from the article: “The Effect of the New Mortgage Rules on Pre-Sale Agreements” By Wesley J. McMillan, Harper Grey LLP
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If you are concerned that you cannot or will not be able to close on your pre-sale, you should seek legal advice as soon as possible.
RBC nudging up their fixed rates a little bit more tomorrow….
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2010/04/rbc-raises-fixed-rates-14.html
RBC says: “We have held off from handing [rate increases] on to consumers but now it has become necessary. The rise is tied to our long-term funding costs which have gone up considerably.”
No other banks have followed RBC yet, but they likely will soon.
CIBC and Scotiabank have followed suit. Increased rates along with tightened mortgage rules – there will be some pre-sale buyers that will be in trouble across Canada.
As well, there is already talk of being “priced out”:
I suppose we’ll be seeing a lot more stories in the paper shortly about folks similar to that guy who made the local news a few weeks ago. They’re sad stories – that’s forsure.
Is now a time to see how the market drops in the months or years ahead?
More to come but there is a clear change developing this April in the Calgary market.
Listings have really dropped off their March and February pace considerably, when adjusted for seasonality. As a result the inventory increase has slowed down in the last 2 weeks.
Sales have dipped as well, but not as much. Easter is throwing off the April numbers a bit.
It’s not yet reflected in sales:new listings but I suspect by the end of the month that number will be trending higher.
Overall it suggests a “front loaded” year – not surprising considering there were probably a lot of rental properties entering the market as well as a rush to get in before rates go up.
We may see an early peak in inventory like last year, possibly in the next few weeks.
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Mike Fotiou says: For 2009, I have a SFH inventory peak of 4601 recorded on March 22. (Unofficial statistic, as it depends on when during the day I checked it)
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Jimmy – can you tell me where you get the seasonally adjusted numbers for listings? All I have as reference is Bob Trumans Daily Stats…a source with seasonality adjustments would be great.
All I can see from the raw numbers is that listings appear to be continuing pace (SFH’s only as per Bob’s #’s, which is the market I’m concerned with anyways):
Jan – added 593 (23% increase)
Feb – added 908 (29% increase)
Apr – added 424 to date – project to 978 (20% increase). Obviously the projection is debatable, but the best I can guess for April.
I can see that the rate of listing growth is slowing. I guess the seasonality adjustments allow us to see if that is normal (i.e. at what point in the spring/summer do we typically see this rate of change?)
Any help is appreciated.
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Mike Fotiou says: For the first two weeks of April, SFH inventory increased 16% compared to the 12% so far this month. This surge in listings isn’t unique to just Calgary: Home Listings Reach All Time High (Globe & Mail)
Intuitively the inventory will increase until July at that time rates up. So I predict that the peak will show a 6000 SFH in the market.
TT:
I took data from Mike F and Bob Trumans site to work out the average change from month to month for listings/sales/price etc. Then I compare the expected percentage change to see what the seasonal pattern should be.
The usual seasonal gain for inventory for end of april is 6.87%, end of may, 9.97%, june 9.29%.
Since this is based on only 4 years, its worth mentioning that the peak month for inventory since 06 has been: October 06 , September 07, May 08, March 09 so one year is often very different from the next. There’s nothing really intuitive about the last few years inventory data unfortunately Daniel.
My data for inventory only goes back to late 05 and the data for sales/listings goes back to 02 so keep that in mind.
6.1%…6.1%… That number seems huge to first time buyers, in fact it’s big to many move up buyers too!
What I read is buyers are focusing on what the “monthly mortgage payments” will be, not the term (5yr) or am (25 yr) final costs are. The problem with focusing on such short term (30 days) a buyer will never see the big picture of acutal costs.
With the 6.1% rates this is good news for affordability. How? Think of it this way.
1. Prices will drop (and listings surge) since people cannot afford homes at the current valuation.
2. Interest rates will go up 6.1…7…8.x% next 2 years causing more price drops and stale inventory.
3. At the end of it (2-5 years?) you’ll have a smaller mortgage for a nicer home at a higher rate that is easier to pay off. (say $250k @ 8% vs $400k @ 6.1%)
Savers will be rewarded for (can you imagine) saving money for a down payment by paying less interest over the term.
At 6.1%, $300K loan for 25 a.m. the monthly payment is $1937.29. Still lots of people can afford it.
At 7.1%, $300K loan for 30 a.m. the monthly payment will be $1995. still Safe?
At 8.1%, $300K loan for 30 a.m. the monthly payment will be $2194.31, some will have difficulty.
It seems that the rates can raise until 10% and a majority people are still safe.
Daniel,
Your calculation would make sense if 300k was the median home price. But it is not. The median is closer to 425. A 425k mortgage @ 3.89 = 2200/month. At the 6.1 you start off with it’s 2744/month.
While the 3.89 mortgage is still sort of affordable, the 6.1 mortgage on 425 k is way “out of reach” for Calgary’s median earner, based on the rule that you shouldn’t spend more than 1/3 of your monthly gross income on housing.
In fact, that 425k house @ 6.1% would technically require an income around the 120k mark.
I’m not all to sure where the 6.1% is coming from though, the discounted rate is currently nowhere near that…
Will
I assumed some people have down payment. For a $100K income family (average in calgary), they save 1 or 2 years, then they can easily pay down $100K. So even for a $425K house, they only loan $325K. Somewhat affordable. Maybe some low income families are not able to make it but anyway there are also low-end houses, also condo, apartment, townhouses. Or suburb area.
I am always wondering how Vancouver people afford the $1000K(avg. price, last month) houses (even property tax) given their current income level there. Can Mike give some information about this? Thanks a lot.
Will
You are talking about a starter home family with 0 downpayment. Those folks aren’t paying for an average home. And as Daniel says, noone puts 0 down.
Also the posted fixed rate is what the bank offers. Most people I know get a rate much lower than that. The chumps who don’t know they can negotiate end up paying the higher rates, along with those of us with poor income/bad credit.
PS there’s an ad on this page for a fixed rate 5 year of 4.19%
But I’m sure the bank would love it Not Mike F if you showed up, willing to pay the 6.1% for them.
Thanks for clarifying your standpoints.
Yes my calculations were based on the median earning purchasing a median priced home with 5% down. As we all know, that 5% gets eaten by CMHC and other fees so the balance is the full purchase price.
While on paper it all looks nice to have 100k down, and a start-up family not wanting a starter home, I think in reality it’s a lot different.
I like to think of myself as a prudent spender/saver and I certainly can’t get anywhere near saving 100k in two years.
So called “starter homes” are also priced in the high 300′s and low 400′s. A lot of folks buying those are not earning anything close average salaries. And those who are earning average salaries don’t want a house that’s in the burbs or in a starter community.
I guess what I’m trying to say is that the balance of “folks making x amount of dollars should purchase a house worth x” is out of the window.
But that’s just my perspective…
I agree with Will that there are some people will be priced out of the market. Meanwhile, I am still surprised by the people’s purchasing ambitions. Just like 2007 peak time, the interest rate is high, the price is high, but there are still lots of people get into the market. The price will be down in the coming months for sure but the affordability might not be the deciding factor.
Daniel:
Completely agree. Price will go down, but affordability will probably be worse. It’s funny to see how some of the bears were doing little happy dances now that mortgage rates are on the up, not realizing that the home they want to purchase will probably cost them more, on a “month to month” basis.
Then again, five years down the road those who bought “at the peak” will have to refinance, and their affordability would probably be worse still.
Kevin over at EHB makes a bold claim that this rally is done…
http://edmontonhousingbust.com/2010/04/death-rattle/
“As we can see, as soon as 2010 rolled around, inventory again started to take off, and surpassed the 500 threshold. I was hesitant to make any declarations in light of the January and February numbers, as while in excess of +500, it wasn’t by extreme margins and wanted to make sure it wasn’t just and anomaly caused by the recoil from fall delistings.
But with the March release of numbers, any doubt was removed… stick a fork in this rally, it’s done. And according to the preliminary April numbers, we’re in for another similar jump this month.
The same story also appears to be playing out in markets right across the country this spring. Even the CREA acknowledged the massive wave of listings, almost 100,000 nationwide. We in Alberta has seen this show just three years ago, we know how it plays out… now the rest of the country is going to get unfortunate opportunity to find out for themselves. “
CM:
I’m not sure this inventory surge is entirely similar to 2007.
The vacancy rate is much lower, suggesting that rather than a market full of empty new or moved-out homes, the market is “trying to move up” while interest rates are low. There obviously aren’t enough first timers now to support the move up buyers.
What that means is that when interest rates get significantly higher, these move-uppers might give up entirely and take their homes off the market.
In 2007/2008 in Calgary we had a massive overbuild situation. This is why the spike in inventory hit our city a year before the financial crisis.
You can call what’s happening in Canada a “Jefferson’s” surge.
Interesting Jimmy, you should e-mail Kevin and see what he thinks of your theory, it could make for a good debate with two well presented arguments.
Will:
You can’t call up an example where a family that has no home is going to buy a non-starter home that’s not in the suburbs. 5% down is uncommon and quite stupid. It’s like pretending that only teenagers are buying new Mercedes.
I totally agree with CM about the inventory speculation. This trend will continue and will not stop in this year. As a result, the bust (say small one) will appear. Also when the inventory is high, more sellers will join in. Although the price will go down, it is still profitable for most of sellers; for example, some bought a house at $240K, now they still can sell it around $400K instead of $450K. So I do not believe Je”"son surge thing gonna happen here.
Jimmy:
I didn’t say a starter is not going to buy a home that’s not in the burbs. I’m saying those homes in the burbs go for high 300′s or low 400′s also. I’m saying that those are the types of homes that folks making less than average are buying.
The folks who are making more than average are therefore no longer satisfied either with buying in their league. After all, they’re “better than that”.
It shouldn’t be this way, but it seems it is. Therefore the system is skewed.
I don’t have the Calgary numbers handy but I am pretty sure their numbers were similar to here… and as per Edmonton’s vacancy rate as reported in April ’07 was 1.1% and 1.5% in October ’07… as of the most recent report the vacancy rate as of October ’09 was 4.5%.
Call me crazy, but that seems to be polar opposite of “much lower”
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Kevin:
You’ve misunderstood my post. I am referring to the percentage of SFH sale inventory that is “vacant/new construction”. I never said I was referring to rental vacancy rates. Nor am I talking about Edmonton.
Calgary %vacancy rates as reported by Mike F:
April 2007 26%, April 2008 24% April 2009 23%.
actually my last post should read
april 08 26% april 09 24% april 10 23% (so far)
Jimmy – I am surprised at your previous statement (@ 8:46PM). “The vacancy rate is much lower…”
From the data you posted above, can you really say that vacancies are much lower? Perhaps it lies in the personal definition of much lower, but to me a 1-3% is hardly something worth noting as an anomoly. Sure, down a couple percent but not a large variance on the YoY numbers.
Eye-balling the data on Trumans’ site (http://www.bobtruman.com/Vacant_Listings/page_1770962.html) I’d go so far as to suggest that, when seasonality is considered, vacant SFH listings are pretty much on PAR when compared back to 2007. We see peak vacant listings in the winter, usually a touch over 30% and then this trends down in the spring to levels around 25% and back up in the fall.
I won’t dispute that there was speculative over-building in Calgary back in 2007-2008 but again I don’t see any notable effect in the percentage of vacant SFH listings during this time.
Given this observation, can you really validate your statement “What that means is that when interest rates get significantly higher, these move-uppers might give up entirely and take their homes off the market.”? Perhaps there is other info that could support this assertion, but I just don’t see it in the SFH vacancy percentage.
Also, can someone explain what a Jefferson’s surge is?
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