Would mortgage interest deductibility help solve Canada's housing affordability crisis?

Is it time to bring out the Bazooka?

It would be unnatural to be around government your entire life and never occasionally wonder: What would YOU do if YOU ran the zoo?

There’s plenty on my list, and none of it will come as a surprise:

• honouring the value of a hard-earned tax dollar by eradicating the obvious waste across the federal government

• getting our CAF members better equipment and pay

• ending the bureaucracy and virtue-signaling that keeps Canada’s energy assets from foreign markets

• focusing some of our massive annual R&D investments into the kind of Clean Tech advances that will help reduce the world’s carbon footprint (see prior posts "60 additional intern jobs" is not an Innovation Strategy April 18-23 and “Clean technology advancements, not circular taxes, is Canada's best hope to reduce global greenhouse gasses and grow our economy” May 11-23)

• ensuring that our Criminal Justice system reflects common sense

• reforming the tax and grant system in a way that gets our country the type of economic activity that what we need right now (see prior posts “Canada can create New Economy jobs without subsidizing foreign corporate shareholders in the process” April 28-23 and “Where's the plan to fix Canada's ‘grim’ business climate?” July 2-23)

• addressing the hollow promise that Canada’s health care system has become

• putting a stop to the well-founded rumour that Canada is the world’s most generous hotel….

The topic de jour, however, is the reality that I wouldn’t be able to enter today’s urban housing market had I been born 30 year later. Today’s first-time home buyers are facing an affordability crisis that may well be the worst that Canadians have experienced since the end of World War II. Interestingly, Canadian home ownership levels have dropped from 69% to 66.5% between 2011 and 2021 (a poor 23rd place in the OECD). Still, that’s a lot higher than the sub-50% level we saw pre-WWII. Whatever the drivers may be, the dynamic is demonstrably unfair to Generation Y (and bodes poorly for Gen Z).

The “why” is certainly of interest to academics, real estate agents, developers, politicians, public servants and institutional trading desks; but for all of the heartfelt chatter on the topic, I’m not sure anyone has tabled a practical solution that will do anything tangible for a husband and wife with a baby on the way today.

If you need some extra space before the due date is upon you, or your lease is soon to end and you don’t want to chin-up to another year of wasted spend at ~$3 or 4k/month, “solving the supply problem” sounds awfully 2028-ish. Increasing the number of homes and condos under construction at any given time is a necessary undertaking for Canadian society. It’s essential, certainly, but as they say: "in the long run, we’re all dead.”

Which means we’re at the point where we have to talk about bringing out the Bazooka: mortgage interest deductibility.

My younger readers have no reason to know this, but back when I still worked in the Mulroney PMO, someone in Maz’s office floated a policy idea that I had a particularly personal interest in: giving first-time home buyers the right to withdraw some of their RRSP savings to help swing a down payment on what is usually the biggest investment they’ll ever make in their lives.

I recall that my heart jumped a beat as I read the Privy Council Office memo laying out the discussion underway at the Dept. of Finance. I can’t recall all of the details, but in the wake of the 1990-91 recession, it was obvious that folks were having a hard time saving enough to buy that first home. I’m sure that Maz’s thinking was that allowing young Canadians to access their modest tax-sheltered retirement savings would both stimulate the residential market and contribute to many other parts of the economy: renovations (windows, HVAC, roofing, landscaping), new furniture, more business for skilled tradespeople, etc. The fact that these RRSP funds were already tax-sheltered would have meant there was only a modest negative impact on the 1993 fiscal picture, making the decision easier to go along with if you were a deficit hawk at the time.

You might wonder what the fuss was about in hindsight, but the Homebuyers Plan was a breakthrough when the Conservatives tabled the legislation over 30 years ago; a program that is now taken for granted, and merely one of many policy tools that are applied to get a first-time homebuyer over the threshold.

A lot of time had passed since 1972 when my Mom and Dad acquired their first home for $28,000 in Ottawa’s Civic Hospital neighbourhood, but it’s worth reminding that it was tough — even then — to swing that initial square on the housing dancefloor. My then 28-year old Father had a good job with PC Leader Robert Stanfield, and my Mom was soon to be working as a part-time night saleswoman at a local furniture store. Despite 1 and 1/4-1/2 incomes, they turned to the vendor to provide the entire takeback mortgage — at a rate of 8%. As my Mom would remind her clients later when she became an Agent for Johnston & Daniel at the broker’s Kingsway office: “Everyone stretches for their first home.”

If she were alive today, I’m sure she’d agree that the current hurdle for Canada’s first-time homebuyers is a far cry from “stretching.”

When I acquired my first house in 1994, I recall withdrawing $16,000 from my RRSP to help get me towards my 20% down payment and avoid having to pay extra for CMHC mortgage insurance. Many licenced financial advisors have a view on the pros and cons of missing out on that tax free RRSP growth, but for most of us, our home is our wisest investment. (Assuming you had the luxury of pulling the down payment together otherwise.)

With the severance cheque that everyone in the Mulroney PMO received in June 1993, along with an $8,000 handshake loan from my parents, I was able to borrow a large enough mortgage to close on a house for $317,700 a few months later. I think my BMO salary was ~$65k at the time, which meant that the purchase price represented 4.9x my annual income. That very same home recently sold for $3 million (Ed note: Holy Smokes!), meaning that my first job with BMO’s then-Chairman Matt Barrett would have had to pay an incredible $612k today for me to have stayed at my original 4.9x home/salary ratio.

There’s no chance that job would pay even 1/3 of that number today. And that’s the primary affordability challenge: no matter how much you’ve saved (or borrowed from family) for a down payment, which is a challenge for every generation, it’s unlikely that you can service the remaining mortgage given just how expensive homes and condos have become over the past decade, relative to current salaries. And that’s for people who aren’t in the “cash income” universe, such as restaurant waitstaff, hotel bellhops, nail / hair salon clinicians, and so forth; it’s even tougher for those that are to prove that they’re a good credit risk.

As every homebuyer knows, banks such as CIBC use a gross debt service ratio to determine the percentage of your gross annual household income required to cover your mortgage expenses, including principal, interest, property taxes and heating costs. The total debt service ratio determines the percentage of your gross annual household income required to cover your mortgage costs, plus all other debts and loans, should you have any, such as student loans or an existing car payment/lease.

I distinctly recall that my 1994 BMO staff mortgage rate had a 7.75% fixed rate and a term of 7 years (inc. the 50 bps staff discount). I chose the 7-year term instead of the traditional 5-year one — which cost me an extra 25 bps — as I wanted to know that I could manage my payments for as long a window as I could envision at that age. You can imagine my mixed feelings a year or two ago when HSBC Canada (see prior post “The Free Market meets lowering costs for Consumers” Oct 23-23) had billboards along the Gardiner Expressway advertising a rate of 1.99% for a 3 year fixed mortgage. In the life of a 25-year mortgage, a guaranteed rate for the next 36 months is bupkis; I’m not saying that short mortgage terms should be banned, but it’s a bit like one of those teaser rates that entices you to sign-up for a streaming service that you probably didn’t really need.

For our Grandparent’s generation, the point of a mortgage was that when the 25-year amortization window was over, you’d own your house free-and-clear. Which would mean that you’d be able to retire someday without worrying if you’d have a roof over your head. It was both a savings vehicle as well as a way to bring stability into your life, having grown-up during the financial and geopolitical lessons represented by the Depression and two World Wars.

In 1994, there was no such thing as a Home Owners Line of Credit (HOLC); the idea that you could borrow against your home equity willy-nilly was laughable. It was forbidden, in fact, so that guys like me couldn’t get in over our heads. If you wanted a new car, hot tub or skidoo, and you couldn’t service the carrying cost of the extra debt, there was no bank-sanctioned mechanism to borrow against the extra bit of equity that you’d built up in your home over the course of the prior twelve month period via regular mortgage payments.

In the years that followed my first purchase, the banking sector has innovated in a variety of ways — with the support of the government of the day: the HOLC, skipping a pair of payments because of a special life event, lump sum principal paydowns, First Home Savings Accounts, TFSAs (Tax Free Savings Account), RESPs, combining your bank chequing account with a stock trading account, weekly amortization schedules, even 40 year amortization terms on gov’t insured mortgages.

Whether or not there’s any innovation juice left to squeeze out of the mortgage lemon, it’s clear that there are two monumental barriers to entry on the current housing market: home prices and interest rates (at least relative to two years ago).

To a certain extent, one is more fixable than the other. If you only have 5%, 10% or 15% for your down payment, mortgage insurance (CMHC or private) can often bridge the gap on the overall price of a house. What you can’t insure your way around is coming in under the minimum-required Total Debt Service Ratio, which is meaningfully impacted by your mortgage interest rate. Whether your financial institution is comfortable at a TDSR of 35 or 41%, there’s a limit to how many policy accommodations they can make, whether for regulatory reasons or common sense on the risk management front.

If you don’t make enough on the income front, there’s almost no normal down payment that makes a difference in this market environment.

If Canada goes into a severe recession, that might change. I suppose that prices could come off another 20% in some regions if sellers get truly motivated. At the moment, however, 2024 looks to be another mediocre year on the economic growth front — which is much more pleasant than what we lived through in 1991, when the economy shrank 2.1%. If I’m right about 2024, buyers who’ve been squeezed out of the housing market won’t be able to rely on some form of divine intervention on the economic front to drive down prices: they either need to save for a larger down payment, get a higher-paying job, or find a romantic partner with an income to share the carrying cost of a mortgage with. Or rent out a room, which creates other complications.

Or push their government to consider mirroring the American policy of tax-deductibility of mortgage interest.

Easier said than done, I know. I don’t doubt that Finance Officials have a standing memo prepared for such discussions, laying out the policy and fiscal challenges that would arise if a government pursued the idea. They’re right. Canada doesn’t need more debt, despite the fact that, as my former CIBC colleague Benjamin Tal recently told BNN: “our housing market is facing its biggest test since the 1991 recession.”

That Mr. Tal cited 1991 might be a hint. What did then Finance Minister Don Mazankowski do in the following federal budget? Allow Canadians to withdraw funds from their RRSP, without penalty, to buy a first home.

For a nation that’s already spending far more than it can afford, giving up additional tax revenue will either substantially increase the national debt even further, or require cuts in others areas of the federal budget (unless the program is a loan against some future retirement savings, TFSA room, etc.?). That leads to tough choices, given Canada’s bleak fiscal picture. Whatever budgetary room we had as a nation over the past few years has been consumed by the existing government on less worthy ideas. But governing is about making tough choices, and a 5 or 10-year trial of this idea, with the size of the mortgage capped at, say, $500k or $1 million, strikes me as a worthwhile discussion, and potentially the only tool we have right now to immediately tackle Canada’s home buyer’s affordability crisis.

Whatever happens to inflation and interest rates over the next 24 months, it’s unlikely that the cost of a $999,999 semi-detached home near Toronto’s York University is going to fall to, say, $680k. What if you could afford a home for $680,000, but the one near your place of employment (or family/friends) is going to run you $999k? Either you commute a long distance in the hopes of finding a home that meets your $680k budget in Oro-Medonte, for example, or you keep renting until the day comes when you can service a larger mortgage and settle into your desired neighbourhood.

I’ve done a simple excel model, and would welcome any input. The goal was to figure out the value of a home that one might be able to swing under the current tax regime, as well as the alternative path with tax deductibility. Here’s the rudimentary impact for a family with combined income of $215,000, a $200,000 down payment, a 7 year mortgage at the current posted rate of 6.79% and an effective tax rate of 40%:

With the same down payment and joint income, it appears that you’ve got a much better chance of finding a home if the government were to “break the glass” on this policy option. Whomever gets the reins of government in 2025, they’re going to find themselves dealing with the same housing crisis that would-be buyers are facing today.

For other parts of the country, such as Chilliwack, B.C., where a $500,000 home on Vedder Road (Ed. note: Eddie has a street named after him in B.C.?) might be more the norm, here’s the model for a gross family income of $100,000:

In this scenario, I was interested in how much extra cash the family would have if they could deduct the interest. It’s possible that my assumed 30% tax rate is wrong, but for the purposes of our model you’d have >$7k more in your pocket each year under the American mortgage interest deduction policy (all things being equal).

That’s a big chunk of change to someone earning $100k/year. Maybe even enough to raise a child, for example. Even $5,000 of incremental cash flow each year would help with baby food, clothes, a crib, diapers, and the other assorted requirements. As you pay down the contracted principal over time, the tax benefit diminishes with the reduction of interest paid each year; reducing the negative impact on the public purse. Then there’s the added benefit that your income is hopefully growing, all while the value of your property is appreciating little-by-little each year.

You can easily create a list of the obvious objections that the Department of Finance would raise if you went down the hall and asked the Deputy Minister to put this program into the next federal budget, even on a trial basis. Keep in mind that the tax revenue hit would be immediate, no matter how short the trial was.

Expensive:

This attempt at resolving the immediate housing crisis might be unaffordable. Canada has limited, if any, fiscal room for expensive new programs. Although only 35% of Canadians currently have a mortgage, we’d have to figure out i) how much tax leakage would result from this idea, ii) what incremental positive economic stimulus would result, if any, iii) how to target it at the type of homes and buyers “we” have in mind (ie. not Westmount {v cool firehall home though} and Forest Hill), and iv) how to make it fair to the 65% of Canadian homeowners who don’t currently have a mortgage, and didn’t benefit from this type of program when they acquired their current home (give them a larger TFSA deduction/year?).

The reason why the potential benefits to family formation seems relevant this week is the Stats Canada report that found that the offspring of “homeowners were twice as likely to own a home in 2021 than those whose parents were non-homeowners.” If home ownership leads to better financial outcomes and family stability over time, even more babies in a nation that needs them, it was encouraging to see that “the positive effect associated with parental property ownership is highest for children with individual incomes below $80,000.”

This sounds like a tool that would let young Canadians, particularly “working class,” invest in themselves by finally having the chance to afford that home. Which is statistically positive for their kid’s financial futures, too, according to that same Report.

Unintended Consequences:

The biggest risk, other than the impact on the deficit, is that people who don’t currently have a mortgage try to use the program to buy a vacation home or investment property, for example, by putting a new mortgage on their existing address and adding leverage where none exists today. Or they put on a HOLC revolving mortgage product and use the funds to buy a J-105 sailboat. Or they move to a more expensive place in the same neighbourhood in the hopes of deducting the interest on the new (and immediately cheaper, after-tax) mortgage they suddenly added. You might need to prohibit the first two, while asking yourself if the latter is a bad outcome.

If a lower-priced home becomes available in a neighbourhood because of an unexpected “move up” by someone who already owned a home, the sudden availability of that cheaper house does in fact put home ownership more in reach for that first-time homebuyer. Maybe you cap the size of the new mortgage for the buyer who was already a homeowner; maybe you disallow deductibility altogether for anyone other than a first-timer. Maybe no one who has been at the same address for more than a decade can access the program, to ensure that retired folks don’t reverse mortgage their 30-year residence and buy a condo in Florida with the proceeds. I’m not against retirement properties, but we’re not trying to stimulate the construction of Florida golf course communities via Canadian tax subsidies.

The permutations are endless, as Finance Officials would correctly advise; does that make the program a non-starter? Maybe. Probably.

Ottawa bureaucrats had plenty of objections in 2009 when I broached the idea of building an underwater pedestrian tunnel to Billy Bishop Toronto City Airport when I was Chairman of the TPA; and yet, there it is today. If this long-standing interest deductibility idea is DOA, what do we do about affordability over the next seven years as the construction industry tries to meet the demand-side of the housing equation? Nothing? That’s certainly the easier path for government, unless you’ve got a baby of the way and are soon to outgrow that one bedroom rental.

That billions are slated to go to Dental Care, instead of this obvious crisis, must be a headscratcher for Gen Y.

Inflationary:

If you give a homebuyer more spending power, by having their dollar go farther via the benefit of interest deductibility, won’t that increase home prices further? Despite capping the size/portion of the mortgage one can deduct, it’s possible that the waters will get muddied in the $400k-$1 million range, even if those are very different housing price-points. The goal is to increase the opportunity for a buyer to acquire a home from within the current supply; if they could service a home that cost $700,000, and they can now pay up to $1,000,000, this should give them more options to choose from — all things being equal. Does that mean the seller of the $1M home will bump the price to $1.25M? I suppose that’s possible, but our straw buyer’s down payment and TDSR hasn’t changed enough to cover that large a jump, which should serve as a governor on artificial price moves that resulted from this policy change.

Equity:

A bunch of us had to finance our homes with after-tax dollars. Does that create some intergenerational unfairness? Perhaps.

The existing TFSA could be sweetened for those folks, or the rules around RRIF withdrawals could be extended to allow for a longer withdrawal period. If you utilize the mortgage interest tax deduction, perhaps you waive an equivalent amount of lifetime room in a future TFSA. Making this program perfectly equitable across generations will be tough, but that’s not a reason to avoid the conversation.

According to every analysis I’ve seen so far, last night’s Federal Fall Economic Statement did little to bridge Canada’s housing supply gap in the near term. Even if everything tabled works as planned, we are still millions of homes short of our nation’s needs. Does that make mortgage interest deductibility the silver bullet of the moment? Maybe not. It’s certainly possible that the Liberals have run-up our national debt to the point where we can’t afford it right now.

That said, if we agree that first-time home buyers are facing an affordability crisis that may well be the worst that Canadians have experienced since the end of World War II, we may have to consider the unthinkable — and bring out the Bazooka.

MRM

(this post, like all blogs, is an Opinion Piece)

(image courtesy of Dr. Seuss)