March 2011

Mortgages aren’t what they used to be

On March 18, some new standards for residential mortgages will come into force in Canada. Will this be enough to rein in the spiralling debt load that Canadians are carrying?

Federal Finance Minister Jim Flaherty was faced with a dilemma:  how could Canadians’ debt load be reduced without triggering a crash in the real estate market? On January 17, 2011, he finally announced three changes that will tighten mortgage credit conditions without restricting access to home ownership:

  • for buyers making a down payment of less than 20% of the property value, the maximum amortization period for a government-insured mortgage is cut from 35 years to 30 years;
  • the maximum amount that can be borrowed when refinancing a mortgage is reduced from 90% to 85% of the home’s value;
  • and the government will no longer provide insurance backing for lines of credit secured by homes, such as the very popular home equity lines of credit.

The first two measures take effect on March 18, and the third on April 18.

Then what?

What will these measures change? Basically, one thing:  the amount of money that Canadians can borrow against their homes. By reducing this amount, the government is trying to reduce the average Canadian’s total indebtedness, which is already alarmingly high, at about 148% of disposable income. The idea is that fewer people will find themselves with debts they can’t repay in the all-too-predictable event that interest rates start to rise.

As shown in the illustration below, the amortization period reduction alone looks like it could have a noticeable impact.


It must be said, however, that in 2010, even though 30% of home buyers chose a 35-year mortgage, only 2% of all buyers would fail to qualify for a 30-year mortgage. So it seems that in almost every case, restricting the amortization to 30 years would not significantly slow the drive towards a more expensive home and a heavier debt load. On the other hand, forcing people to repay their mortgages more quickly will allow them to replace a debt with savings that much sooner.

Other effects

As for reducing the mortgage refinancing maximum from 90% to 85%, it sends a message to consumers who are tempted to use their home as a bank machine. This type of borrowing has increased twice as fast as mortgages in the past 10 years, and now accounts for 12% of household debt.

Lastly, eliminating government insurance on home equity lines of credit is a way of transferring the credit risk to the lending institutions to encourage them to reduce the flow of credit. Until now they have been very generous with this type of loan, since the risk was borne by taxpayers.

Once, twice, three times

This is the third time in 26 months that the federal government has tightened credit conditions in the mortgage market. In 2008, the maximum amortization period for government-insured mortgages was reduced from 40 to 35 years (now 30 years). And in 2010, a regulation was brought in that forced all mortgage applicants to qualify for a 5-year fixed-rate mortgage, no matter what term they were seeking.

In the long run, some economists fear that by curtailing debt, the government might cause a slowdown in the real estate market, and even hobble economic growth. On the whole, though, the effect is expected to be real, but modest, combined with the impact of the overall economic situation. The CMHC predicts that Canadian housing starts will decrease by 6.5% in 2011, and sales of existing homes by 1.1%. Nonetheless, selling prices for existing homes are expected to increase by 2.9%.

Other observers are less optimistic, however, and predict that higher interest rates in conjunction with a credit squeeze will result in a significant drop – up to 25%!– in residential property values over the next few years.

Time will tell who is right, but meanwhile, Canadians would do well to pay attention to the message the Minister of Finance is sending them:  be prudent.