Thank you to our friend, Nolan Matthias of Mortgage360, for sharing your mortgage expertise.
This article contains everything we know about the new First Time Home Buyer Incentive, plus the fine print that will make most home buyers run from the program like it is a commission breath salesperson at a show home. Starting on September 2, 2019, the First-Time Home Buyer Incentive will become a reality. With that date fast approaching there are still a lot of unknowns. This post will be updated as we get more information HERE.
When the Feds first announced the First Time Home Buyer Incentive program back in March the benefit of the plan seemed obvious. It seemed like the program would increase the price of a home that a first time home buyer could buy. It seemed to do so by giving the buyer a 5–10% incentive to increase their purchasing power. Unfortunately, this is not the case. It is the furthest thing from it. In fact, it seems like the program is little more than an elaborate tax on first-time homebuyers and the mathematically challenged. The details are in the fine print.
The smoking gun that confirms that this program does little to increase buying power is hidden in plain sight in one of the quick fact bullet points posted on the CMHC website. That bullet point reads, “a participant’s insured mortgage and the incentive amount cannot be greater than four times the participant’s qualified annual household income.”
What does four times the participants qualified annual household income mean to borrowers? It means you have to buy for less than what you would otherwise be eligible.
Using the example on the CMHC website here is a comparison of what someone might qualify for under the program versus what they would generally be eligible for.
Let’s first look at the purchase of a brand new home with a 5% down payment and a 10% equity share under the program.
Down payment (5% )—$17,500
Incentive (10% )—$35,000
Insured Mortgage (including premium)—$305,830
Mortgage + Incentive—$340,830
If the mortgage and the incentive total $340,830 the maximum household income for this mortgage is $85,207. $340,830 ÷ 4 = $85,207
But how much would a first-time homebuyer with an $85,207 income typically qualify for? A significantly higher amount of $425,914, including the insurance premium. That put’s their maximum purchase price at $430,000 with a 5% down payment, not the $350,000 that would be the maximum under the program. Additionally, by CMHC’s current standards, the payment that they can afford is $560 more than what the program allows.
So to use the First Time Home Buyer Incentive, a first time home buyer loses 18% of their buying power. They need to buy a significantly lower priced home than what they can afford with a substantially lower payment.
So why would someone who can afford a $560 higher payment choose to give up 10% of their equity in exchange for around $163 in monthly savings? It makes little to no sense unless you think the value of the property is going to tank. But if you think the value is going to tank, you probably shouldn’t be buying it.
One might point to the fact that the incentive is being called an interest-free loan. But it is anything but interest-free. Don’t be fooled by that representation. Sharing the appreciation of the property value will almost certainly cost you more than paying interest on a mortgage. This looks more like a tax on the mathematically challenged than an interest-free loan.
Those who crunch the numbers likely won’t opt into this program. It doesn’t increase buying power, and it gives up equity to the government for no obvious good reason. At least none that we can see. You are still borrowing the incentive money. You still owe it to the government. And the idea that it is interest-free is a fallacy. The only thing worse than paying someone interest is paying out equity with no ceiling on the payout.
So first time home buyers who are looking at the program have three options. You can save a 5% down payment and purchase for the normal and the higher amount you would qualify for. You can use this program to get a mortgage for about 18% less than what you otherwise qualify for and give up a 5–10% of your equity. Or you can choose not to use the incentive and buy for a lower price than you are eligible for, but own the whole home. Incentive or not, if you are getting approved for an insured mortgage in Canada you are getting approved for the one you can afford. Not only by CMHC’s usual standards but also by the standard of the much more stringent stress test. A small 5–10% equity share with the government has little upside but a lot of potential risks and downsides. Risks we wouldn’t be willing to take with our mortgage.
Like they teach in business school, don’t take partners in your business unless you have to. That logic seems pretty sound for your home as well, especially when your partner is the government, and they get to make the rules.
Further Comments & Information
The information posted on CMHC’s website claims the program will reduce the payments of first time home buyers. It will do this without increasing the amount they need to save for a downpayment. The Federal Government will also increase the RRSP withdrawal limit from $25,000 to $35,000.
The Government of Canada has allocated $1.25 billion over three years for this program. The incentive will be available to first-time homebuyers with annual household incomes up to $120,000.
The government claims that the program will reduce the monthly mortgage for your first home by up to $286. This assumes an interest rate of 3.89% , more that one percent higher than current rates. Most borrowers will not reduce their mortgage payment by anywhere close to $286. Our calculations indicate that if a borrower maxes out the program and gets a normal rate of 2.89% , their maximum reduction would be $267. For one to max out the program, all of the stars would have to align. The household family income would need to be almost exactly $120,000 per year without going over. They would also have to be purchasing at the exact limit of the program.
The government claims that this program will mean more money in the pockets of Canadians. They estimate it will help up to an estimated 100,000 families across Canada. Further, they suggest that the savings will be used to spend on things like healthy food, sports activities for their kids, or even save for the future. Experience suggests that when savings are incurred by most borrowers, these are not the areas they end up spending money. In fact, these savings will likely go to things like car payments, dining out, and other entertainment related expenses.
Quick Facts about the First Time Homebuyer Incentive From CMHC’s Website:
Our comments and questions are italicized.
- Canada’s First-Time Home Buyer Incentive will help qualified first-time homebuyers purchase their first home as the incentive reduces their monthly mortgage payment, without increasing the amount that they must save for a down payment. The program will launch on September 2, 2019, with the first closing on November 1, 2019. This means that in order to use the program you must right an offer after September 2 with a closing date to follow two months later. Our experience is that two months is on the long side between writing an offer and taking possession of a property. Also, expect high demand in properties under $500,000 during this period, which may increase prices and likely trickle up to higher end homes as well.
- The incentive will allow eligible first-time homebuyers who have the minimum down payment for an insured mortgage with CMHC, Genworth or Canada Guaranty, to apply to finance a portion of their home purchase through a form of shared equity mortgage with the Government of Canada. It is good to see that all three insurers are participating. This is important as Genworth and Canada Guaranty offer slightly different options than CMHC. The question is how will these be underwritten? Will they take more time to complete? How will the funds flow through to the lawyers to close the deal? Will it flow through the lender or will there be separate deposits made directly to the lawyer? At this point these items need to be clarified.
- For the purchase of an existing home, an incentive amount of 5 percent may be available. For the purchase of a newly constructed home, an incentive amount of 5 percent or 10 percent may be available. What will be the criteria for the additional 5% for a new home? Will this cause issues in the resale market, subsequntly making existing homes less valuable than new? Our concern would be that existing homeowners in areas close to new developments will see their property values decrease.
- Doubling the incentive for purchasers of new homes encourages new housing supply. Increasing housing supply potentially has a negative affect on home values. On the other hand more supply makes homes more affordable. Whether this is a good thing or a bad thing remains to be seen.
- No ongoing repayments are required, the incentive is not interest bearing, and the borrower can repay the incentive at any time without a prepayment penalty. Big concerns here. If the borrower decides to pay back the incentive without selling the property, how is the value determined? Will an appraisal be required? And will the appraisal assume a quick sale, normal days on market, or the assessed value for tax purposes? This seems like it could turn into a bureaucratic nightmare.
- The government shares in the upside and downside of the change in the property value. In business school you are taught not to give up equity in your business unless you have to. Is giving up equity in your home really the best idea? After a payout penalty with the bank and paying out the government a home owner could be left with not a heck of a lot upon sale. Further, how would the upside of a change in property value compare to the interest rate on a normal mortgage. The cost of this loan could end up being substantially higher than a normal mortgage.
- The buyer must repay the incentive after 25 years, or if the property is sold. What happens after you pay off your 25 year mortgage? Do you simultaneously have to do a refinance to pay out the remaining incentive? This could be problematic. And what happens if you can’t pay it out? What is the recourse? You haven’t made payments for 25 years and then all of a sudden you owe the government 5 or 10% of the property value which you have to pay immediately? We won’t know the complications of this for at least 15–25 years.
- The incentive will be available to first-time homebuyers with qualified annual household incomes up to $120,000. At the same time, a participant’s insured mortgage and the incentive amount cannot be greater than four times the participant’s qualified annual household income. This is the big issue. So even if you qualify for a bigger mortgage, you may not be able to buy the house you can actually afford and use this program. For example, as of this writing, a $120,000 income can qualify for about $606,221.07. In order to use this program you would only be able to get a mortgage plus incentive of $480,000. A couple who makes $80,000 might qualify for a $380,000 mortgage, but will only be able to use the program up to $320,000. In other words, by traditional standards borrowers using this program can afford far more than what they are buying for. Which means the savings of $100–267 per month isn’t really going to make a huge difference financially. More than likely they will just use the savings to buy fancier cars, clothings, and meals. Where CMHC normally allows 39% of a person’s income to go towards housing costs, this program seems to only allow 30% . That means that the program does nothing to increase the price of a home a person can afford. It actually forces them to buy for less than they can qualify for if they want to use the program. Oh, and to take full advantage of the program you have to buy a new home.
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