The Canadian government should consider being flexible on its new mortgage lending rules because the impact has been longer-lasting and more significant than originally intended, Toronto-Dominion Bank says.

Home sales were about 40,000 lower between the final quarter of 2017 and the same period a year later than they otherwise would have been without the rules, according to a note to clients Tuesday by TD economists Rishi Sondhi, Ksenia Bushmeneva and Derek Burleton. That translates into about a 7% decline in sales, they said.

There is also evidence of a shift in business to private lenders who are not subject to the rules, known as B-20 and implemented by Canada’s banking regulator. The economists estimate the share of borrowers in Toronto accessing funds from alternative lenders increased to 8.7% in the second quarter of 2018, from 5.9% in the same quarter a year earlier.

The changes mean federally regulated lenders must now run a 200 basis-point stress test on new mortgages, to ensure the quality of lending remains high amid escalating home prices. The measures are disproportionately affecting first-time homebuyers, who normally account for between 40% and 50% of the market, as well as cities that have more youthful demographics like Toronto and Vancouver, TD said.

‘One-Size’

“Right now it’s a one-size-fits-all type of policy, and borrowers differ in their ability to service their mortgage, and they’re different in terms of their risks,” Bushmeneva said in a phone interview. She said policy makers could consider being flexible around the 200 basis point stress test limit, given it’s “somewhat arbitrary,” and doesn’t take into account the credit-worthiness of borrowers or their life stage.

Immediately removing the rules would increase Canadian home prices an additional 6%, on top of Toronto-Dominion’s current forecast for a 4% increase, by the end of 2020, the economists wrote, adding that would boost home prices by about $32,000 on average.

The rules have pushed potential buyers into the rental market, leading vacancy rates for purpose-built rental units to fall by as much as 30 basis points in Toronto and Vancouver. That poses a “significant challenge” as those markets are already “severely under-supplied,” with current vacancy rates at just 1%, the economists wrote.

Toronto-Dominion joins fellow-lender Canadian Imperial Bank of Commerce, along with realtors and builder groups in calls for the government to revisit its B-20 rules.

According to the note, Toronto-Dominion also forecasts:

• Housing starts to trend lower through 2020, as B-20 crimps market for new housing
• New housing construction will be a drag on growth next year, though healthy job gains and robust population growth will provide a floor. Currently, the bank sees Canadian home prices stabilizing by mid-year and rising 4% by the end of 2020
• However, if B-20 was immediately removed, nationwide sales and prices could be about 8% and 6% higher by end of 2020, equating to about $32,000 difference in avg Canadian home price, with disproportionate impacts in Toronto, Vancouver.
• Removal of B-20 would represent a “significant near-term boost to housing activity, though at a longer-term cost of worsened affordability”