Canada Announces Stringent Mortgage Rules

Jim Flaherty, the Canadian Federal Finance Minister, has recently announced more stringent mortgage rules with a view to deal with the worries regarding the high household debt in the country.

Addressing a news conference in Ottawa on Monday last, Flaherty said that his government had acted to protect as well as reinforce the Canadian residential real estate market in 2008 and once again in 2010. Adding, he emphasized that his government continued to do so even in the present times.

Precisely speaking, Jim Flaherty introduced three major changes and they are as follows:

  • The utmost period for amortization for a mortgage insured by the government was brought down from 35 years to 30 years.
  • The ceiling for Canadians to borrow against their home equity was also reduced from 90 per cent to 85 per cent.
  • The government insurance support on home equity lines of credit (HELOC) has been done away with.

Market observers are of the view that the first change is expected to have the maximum effect. It is necessary for people buying a home with down payments lower than 20 per cent of the total value of the residential real estate to purchase mortgage insurance endorsed by the government through the Canada Mortgage and Housing Corporation (CMHC).

According to the latest rules announced by the Federal government on Monday last, mortgages that are amortized for more than 30 years would no longer be eligible for the government-backed mortgage insurances. This would, in fact, make it practically impossible to obtain extremely leveraged mortgage of over 30 years in Canada.

When different companies started issuing mortgages for 40 years or even more, Ottawa had fixed the limit at 35 years in 2008 prior to the new set of rules announced by the Federal government on Monday limiting the maximum amortization period of home mortgages to 30 years.

Endeavor to Stem tide on consumer debt

Announcing the new set of mortgage rules, Flaherty hoped that the new measures would help to considerably reduce the total interest payments for the Canadian home owners. In effect, the Federal Finance Minister was denoting to the fact that people obtaining a longer amortization on their mortgages would eventually have to pay much more in terms of interest over a period of time.

According to the existing mortgage rules, an interest rate of five per cent on a mortgage of $300,000 amortized for 35 years would require the home owner to make a monthly payment of $1,514. However, when the new rules come into effect from March 18 this year, a similar mortgage amortized for 30 years at five per cent interest rate will require the home owner to pay $1,610 in monthly payments - a difference of $96 every month. However, when you take the entire period of the mortgage into consideration, it totals to a whopping savings of around $56,139!

The Federal Finance Minister has described the move to reduce the amount that a home owner can borrow against his/ her home equity to 85 per cent as an initiative by the government to make sure that the Canadians are able to retain more equity on their homes. According to Flaherty, this move will help to help saving by means of home ownership as well as regulate repackaging consumer debt into mortgages.

On the other hand, the final change in the mortgage rules, to remove government insurance on home equity lines of credit (HELOC) was a result of Ottawa's apprehensions that a few particular financial institutions were permitting the home owners to include too many consumer purchases into the mortgages insured by the Canada Mortgage and Housing Corporation (CMHC).

Flaherty opined that on the whole this was risky since a number of those loans are never used to create housing. On the contrary, such loans are used to purchase cars, boat and big-screen television. The Federal Finance Minister emphasized that this was never the purpose for designing home insurances.

Even as Flaherty described the changes in the mortgage rules as 'moderate', they, in fact, did not incorporate any augmentation to the existing five per cent minimum down payment necessitated by Ottawa for anyone purchasing a home. In addition, the changes also were in a lower pitch as they did not include a proposal that had come up in the previous week and would have made it necessary for inclusion of 100 per cent condo fees in the list of expenses that are calculated against income when the financial institutions actually mull over granting a mortgage to any candidate. The existing rules stipulate the inclusion of only 50 per cent of the condo fees.

Meanwhile, the reaction of the market observers to the news has been more or less positive. Michael Gregory, an economist at the Bank of Montreal (BMO), observed that there has been lots of guesswork that more stringent mortgage insurance rules would also be incorporated in the forthcoming federal budget.

However, with gossips floating around that the budget may also prompt an election; the Conservative government in Canada has obviously thought that the issue was significant enough to be put on the table prior to a budget document that may perhaps never be passed, opine Gregory. He said that the lowered amortization period is an important change that would, in effect, lower the demand for homes/ mortgages lower than what it would have been otherwise. This is likely to be in favor of anyone seeking to buy a new home.

Meanwhile, Jim Murphy, the head of the Canadian Association of Accredited Mortgage Professionals (CAAMP) pointed out that the recent announcement regarding the changes in mortgage rules ought to facilitate in enhancing the equity in homes as well as allay apprehension regarding the increasing levels of consumer debts. However, Murphy said that CAAMP had proposed that Ottawa also tighten the eligibility standards for mortgages with 35 years amortization period, instead of putting an end to it in general.

Yet, Murphy is contented that the government did not increase the levels of the minimum down payment. According to him, had the government done so, it would have had slowed down the housing market. Murphy is of the view that the changes in the mortgage rules are expected to generate a scuttle of buyers into the housing market prior to March, when the changes are scheduled to be effective, and this would eventually result in additional sales during the first quarter of the current year.

In fact, the changes in the mortgage rules come in the wake of the warnings issued by the Bank of Canada on the rising levels of household debts in the country. Lat December, Mark Carney, governor of Canada's central bank, had cautioned households and businesses in Canada not to be silenced by the prevailing low rates of interest since the consequences from a hike in the interest rates was likely to be very quick.

Interest rates 'Will Rise'

On Monday last, Flaherty said that though the interest rates are currently low by historical standards, they would rise eventually. At the same time, he rejected the concept that the announcement regarding the changes in mortgage rules was scheduled to pave the way for the central bank's subsequent decision on interest rates that are likely to be revealed shortly.

Addressing the press conference on Monday last, the Federal Finance Minister emphasized that the specific timing to announce the mortgage changes on that day was in no way related to any announcement regarding the interest rates on mortgages. Flaherty pointed out that the Bank of Canada governor Mark Carney and he spoke to each other frequently to discuss such issues and they always endeavor to ensure that the government's policies harmonize with the monetary polices of the Bank of Canada.

In the preceding week, a deputy governor of the Bank of Canada, Agathe Côté, told a gathering at Kingston, Ontario, that considering the high levels of debts of a number of households in the country, an unexpected decline in the Canadian housing sector may perhaps have an effect on other areas of the economy too. She further said that in the instance of being hit by such a shock, Canadians would be required to curtail their expenditures.

The recent announcement by Flaherty is the second time in the last three years when the federal government has initiated measures to tighten up on the mortgage rules. It may be noted that earlier, in 2008, also the government had introduced numerous changes in the then existing mortgage rules. Some of the changes affected in 2008 are mentioned below:

  • Lowering the maximum amortization period from the then existing 40 years to 35 years.
  • Necessitating a bare minimum down payment of five per cent of the total value of the residential real estate.
  • Laying down a prerequisite for a steady minimum credit score.
  • Introducing new standards for loan documentation.
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