Barry Klatt

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How Jim Flaherty’s new mortgage rules will sink house prices

By Michael Babad, Globe and Mail

Flaherty moves on mortgages

The Canadian government continues to move aggressively to cool down the housing market amid fears in some quarters of a bubble in the making.


As The Globe and Mail's Bill Curry, Grant Robertson and Tara Perkins report today, Finance Minister Jim Flaherty is acting for the fourth time, reducing the maximum amortization for a government-insured mortgage to 25 years from 30 years. He's also reducing the amount of equity homeowners can take out of their homes in a refinancing to 80 per cent from 85 per cent. The changes take effect July 9.


Canada's bank regulator, the Office of the Superintendent of Financial Institutions, has also acted already, and unveiled the final guidelines today.


This comes amid concerns that the market is overheated, notably in major cities like Vancouver and Toronto, and as Canadian consumers carry ever higher debt burdens, even though loan growth is slowing.


Mr. Flaherty is "prudently taking out some insurance" with today's move, said chief economist Craig Alexander of Toronto-Dominion Bank, by gently tapping the brakes.


Debt growth in Canada has slowed, but is still eclipsing income growth, a threat to the economy should it continue. The ratio of debt to personal disposable income among Canadian households has climbed to a startling 152 per cent. Had steps not already been taken, TD believes, that would have climbed already to 160 per cent, the level that sparked troubles in the United States and Britain.


Mr. Alexander says the cumulative impact of both  of today's moves by Mr. Flaherty and OSFI should be to reduce house prices by five percentage points from where they otherwise would have been, and sales by 10 percentage points. That takes more than a year to filter through, Mr. Alexander said, and is based on all else being equal. What he means is that the move could, for example, lead to lower sale listings, in turn tempering a price decline.

Bank of Canada Governor Mark Carney has warned repeatedly of the threat to consumers should there be another financial shock and rising unemployment. Some observers had believed that the run-up in debt could force him to hike rates, but, with Mr. Flaherty's action today, the central bank chief now has more wiggle room to hold rates as he sees fit amid the mounting global uncertainty.


"These latest steps to tighten mortgage rules are part of efforts to avoid one of the negative side effects of having very low interest rates for a long time," said chief economist Avery Shenfeld of CIBC World Markets, which believes Mr. Carney won't hike his benchmark lending rate until 2014.


"With the economy not strong enough overall to deal with a significant ramp-up in rates, it make sense to use alternative targetted measures to address one of those issues, the risks of a bubble in home prices and associated mortgage debt," Mr. Shenfeld said. "These latest moves are just some further fine tuning, but we are already seeing a cooling in house price inflation, and a slower pace to consumer debt. If these measures add to the cooling in housing, it will take the pressure off Carney to use the blunter instrument of interest rate hikes to meet that objective, leaving other parts of the economy, including business capital spending, still getting a much needed boost."


In Halifax, Mr. Carney said the move will support the "long-term stability" of real estate and help guard against the risks associated with swollen debt levels.


Robert Kavcic of BMO Nesbitt Burns says the reduction in the maximum amortization period is equivalent to an increase in mortgage rates of about 0.9 of a percentage point. (That assumes a five-year fixed mortgage rate of 3.3 per cent on a $290,000 mortgage, after a 20-per-cent down payment on an average home.)


"Notably, the impact is bigger than the switch from 35- to 30-year mortgages, which at current mortgage rates, would be equivalent to about 0.6 percentage points of tightening," Mr. Kavcic said.


"It’s also important to keep in mind that the amortization change won’t impact affordability across the entire market, but rather those that would be taking a 30-year amortization," he added.


"As we’ve observed around prior mortgage rule changes, some housing market activity will likely be pulled forward ahead of the implementation date ... with a subsequent payback thereafter. After the 35-year amortization was eliminated last March, for example, existing home sales fell by more than 3 per cent over the subsequent two months."


Mr. Alexander described Mr. Flaherty's action as a "very constructive step." It shows, he added, that the Canadian government agrees with the Bank of Canada that real estate valuations and debt loads are out of hand.


The combined moves, equivalent to hiking mortgage rates by between 1.5 and 2 percentage points, should cut between one-third and one-half of the overvaluation in the Canadian real estate market, Mr. Alexander said.

"With respect to recent indicators and the need for such measures, resale house sales activity through the first five months of the year is 7.5 per cent higher than over the same period last year," said Mark Chandler, chief of fixed income and currency research at RBC Dominion Securities.


"However, price pressures have abated considerably, with weighted residential prices up just 1.1 per cent on a year-ago basis ... Mortgage credit growth has slowed somewhat as well, though still remains above the pace of personal disposable income (BoC estimates growth at 6.9 per cent on a year-ago basis as of April, the annualized three-month trend is at 6.3 per cent)."


Today's move, said Adrienne Warren of Bank of Nova Scotia, could spark an initial burst of activity.


"I see it as another move by Ottawa to reinforce cautious lending practices in response to high household debt levels and high home valuations," she said. "The change is significant enough to dampen housing demand and credit growth, though we could see a rush to lock in a 30-year amortization while they are still available."


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