In an election year, the federal Liberals are eager to share — albeit partially — the housing pains of low- to mid-income households who have been priced out of the housing market.
Budget 2019 announced a new First-Time Home Buyers Initiative (FTHBI) to assist new homebuyers and indirectly encourage the supply of new housing. At the heart of the initiative are new shared equity mortgages that will help to lower monthly mortgage payments for an expected 100,000 first-time home buyers over the next three years.
Though new to Canada, shared equity mortgages (SEM) have been tried in the past in Australia, the U.K, and the U.S. Though research on the effectiveness of SEMs and its variants is not readily available, they have usually been introduced by governments faced with housing affordability challenges.
The details of the Canadian plan are not yet known. The government has entrusted the Canada Mortgage and Housing Corporation (CMHC), which will partner with homebuyers for the mortgages, to release the terms and conditions later.
While CMHC is busy delineating the contours of the FTHBI, we will take this opportunity to offer a perspective on SEMs.
In a typical SEM, a lender takes an equity stake in the property being purchased. Whereas the ownership remains with the buyer, shared equity implies that the lender will claim a part of capital gains or bear losses. Consider the following example.
A first-time home buyer is interested in purchasing a newly constructed house for $400,000. The buyer comes up with a five per cent ($20,000) down payment for a CMHC insured mortgage. CMHC will provide up to 10 per cent of the purchase price as an SEM ($40,000).
SEM effectively reduces the mortgaged amount from $380,000 to $340,000, which the government believes results in a $228 reduction in monthly mortgage payments.
For many struggling households, $228 in monthly savings will be helpful. Also, the reduced loan amount will help partially address the raised bar for mortgage qualification resulting from the stress test, which requires the borrowers to qualify at a rate 200 basis points higher than the contracted rate.
The budget also suggests the government understands that buyers are only part of the equation when it comes to tight housing markets. The questions of supply is also paramount: a budget backgrounder rightly recognized that the “most effective way to address affordability in the long run” is to “increase the supply.”
Thus, the SEMs proposed in the budget involve a 10 per cent equity stake in a newly built home and only a five per cent stake in an existing home. The differential is designed to increase the demand for new housing, which should in turn increase housing supply.
While SEMs could be moderately effective in increasing housing supply if combined with other initiatives, they are likely to do little to address supply challenges in expensive housing markets.
That is because in order to participate in the FTHBI, a household’s income must be under $120,000, and the mortgage and incentive amount together cannot be greater than four times the household income. Finding adequate shelter priced under $500,000 for growing households will be a formidable challenge in places like Toronto and Vancouver where housing affordability is already acute.
At the same time, FTHBI will pit qualifying households, who will only pay 90 per cent or 95 per cent of the eventual price, against families who do not qualify and will be forced to pay full price.
Finding adequate shelter priced under $500,000 for growing households will be a formidable challenge in places like Toronto and Vancouver where housing affordability is already acute
While homebuyers might find the initiative helps them buy a home, there will be a downside when they sell, and must share the capital gains with the CMHC. (In the U.S., private investors at times claimed 50 per cent or more of the price appreciation, depending on the terms of the arrangement, for as little as a ten per cent stake. There is no indication the CMHC will be so harsh.) Also, participating households might have to incur additional costs (interest payment on equity loan) over time.
Over three years, 100,000 beneficiaries of the FTHBI will represent fewer than 10 per cent of the homebuyers in Canada. Though the number of affected households is small, still the recipients will likely push the price of low-priced homes upward, which could inadvertently worsen affordability for the same buyers the government is trying to help.
In the late seventies, shared equity and shared appreciation mortgages were tested by private lenders in the U.S. However, such mortgages failed to take off because private lenders were not keen on waiting for undetermined years to claim their share of the capital gains.
The lack of private interest is perhaps the reason that the Liberal government has asked CMHC, a crown corporation, to extend credit for the initiative.
SEMs are not without investor risk, especially in today’s market where housing prices are falling and the economic outlook for the next couple of years is increasingly recessionary. CMHC may end up sharing more capital losses than gains if average housing prices continue to fall.
In the past few years, housing affordability has worsened for a very large segment of the Canadian population, especially in large cities. Even if SEMs were to improve affordability for 100,000 first-time home buyers over three years, is the initiative an adequate response or just “a snowflake on an iceberg”? Only time will tell.
Murtaza Haider is an associate professor at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached atwww.hmbulletin.com.