Tighter Mortgage Rules Will Help Save Canadians From Themselves
This article appeared in the Financial Post on June 21st, 2012.
OTTAWA — Without the tool of interest rates to temper the housing craze and with the threat of Europe still overhanging the sector, Ottawa had to use other means to slow things down and, at same time, lessen consumers’ exposure to the market.
For that, it chose once again to tighten the screws on mortgage lending, a move that surprised many, but one that Canada’s finance minister characterizes as the government’s role in providing a “prophylactic function” — helping average Canadians save themselves from themselves.
Jim Flaherty, who had insisted it was up to commercial banks to take the lead on mortgage lending, on Thursday took that action himself — reducing the amortization period for government-backed mortgages and limiting home equity loans, among other measures.
“The government doesn’t necessarily need to be, at the end of the day, in the mortgage-insurance business,” Mr. Flaherty told reporters. “But we are in the business, so we have to ensure that the exposure to the taxpayers of Canada is reasonable.”
Mr. Flaherty said he wanted to “avoid the kind of issues that have happened in other countries in recent years. And I’m satisfied we are and our market is OK.
“But I think there’s a prophylactic function for government on this with respect to insured mortgages and it’s our job to try to be ahead of things and act — and act in a measured way, listening to the market. And I have been listening to the market and, quite frankly, I don’t like what I hear, particularly in the condo market.”
Thursday’s announcement marked the third time in four years that Ottawa has gone this route to head off over-zealous borrowing by homeowners, many of whom might not be able to carry their debt load.
The new rules, which take effect July 9, will see the maximum amortization period for government-insured mortgages fall to 25 years from 30 years. The limit for borrowing against the value of a home drops to 80% from 85%, while the maximum gross-debt ratio is fixed at 39% and the total debt-service ratio will be 44%.
The biggest surprise, however, was a new rule to limit government-backed mortgages to homes purchased for less than $1-million.
“At long last, the Canadian government is coming to the realization that the ball was in its camp all along,” said Louis Gagnon, a finance professor Queen’s University.
Mr. Flaherty has been “reluctant over the past several weeks to further tighten these rules, arguing it was up to the banks to stop people at the gate,” he said.
“In fact, what we’re dealing with is a systemic issue. It’s really in the government’s hands,” Mr. Gagnon said. “It’s always going to be important for the government to be pro-active on this front.”
Mr. Gagnon added: “These new rules are long over due. We know the pace of growth of consumer loans is not growing, it has actually come down a bit, but not on the mortgage side.”
The Bank of Canada has reluctantly been waiting on the sidelines — even as household debt ballooned — waiting to see how the European fiscal crisis plays out, and what impact that will have on the Canadian economy and that of its struggling neighbour to the south.
The central bank’s trendsetting lending rate, its lever for guiding monetary policy, has been stuck at a near-record low of 1% since September 2010.
The initial intention was to get consumers and businesses spending again as Canada edged out of recession. That indeed worked — too well, as it turns out.
Debt-to-income ratio of Canadian households has reached a record high of 152%, once again raising alarm bells that consumers were getting in way over their heads.
Just last week, the Bank of Canada warned consumers to brace for a possible shock wave from a worst-case scenario — a European banking collapse followed a housing crash and a jump in unemployment.
For his part, Bank of Canada governor Mark Carney also welcomed the tighter mortgage-lending rules, calling them “prudent and timely measures” in a speech in Halifax on Thursday.
Mr. Carney said the measures “support the long-term stability” of the housing market and “mitigate the risk of financial excesses.”
And while Canada’s “favourable economic performance” has relied on strong household spending, growth cannot “depend indefinitely on debt-fuelled household expenditures, particularly in an environment of modest income growth.”
Speaking later to reporters, Mr. Carney once again stressed the “No. 1 domestic risk to the Canadian economy is the potential for household finances to evolve in an unsustainable fashion.”
“These measures reduce the No. 1 domestic risk.”