Lenders we deal with...
With the summer vacation season only a few days away, a series of changes to rules for insured mortgages, some expected and some not, rocked the Canadian mortgage world last week. The unexpected changes came on the same day as the ones which were expected (which also came a bit earlier than predicted), making for a long list of new material changes for the industry and other observers to consider, process and comment on. Reactions have generally been predictable and, although some of the key changes were not telegraphed in advance (as previous changes since 2008 had been), the government’s ongoing discourse around very cheap credit, consumer debt growth and stretched housing valuations in some markets has been consistent for some time.
CAAMP reacted quickly, suggesting that, with last week’s changes, the government “may have overreached” and speculated that they may “precipitate the housing market downturn the government so desperately wants to avoid”. This response may be partly a product of the fact that the changes announced last week which will have the most impact on the housing market were not specifically hinted at by the government and were therefore un-anticipated by the industry. They also came against the back-drop of a co-operative and consultative process surrounding the other OSFI changes to mortgage underwriting guidelines which were announced the same day. But the difference between CAAMP’s concerns and the Finance Department’s thinking in making these changes probably comes down to a matter of degree when it comes to a housing market downturn. CAAMP suggests that the changes may precipitate a downturn that the government wanted to avoid. The government clearly wants to avoid a rapid and severe decline which could shock the market and threaten the larger economy. Instead, they are taking these steps now to cool the market, slow the pace of house price increases and restrict mortgage qualification at the lower end – in terms of both the amounts that can be borrowed and the number of borrowers who “barely” qualify. Finance Minister Flaherty estimated that the changes would impact only about 5% of home buyers.
The Bank of Canada has been very clear in its position that household indebtedness represents the biggest domestic threat to the Canadian economy. Not surprisingly, Bank Governor Mark Carney supported the changes, saying that they will contribute to long term stability by creating conditions for the “sustainable evolution of the housing market”. Carney went on to say in a speech last week in Halifax after the mortgage rule changes were announced that “our economy cannot depend indefinitely on debt-fueled household expenditures”.
The Canadian Real Estate Association called the mortgage rule changes “a measured response to the government’s often stated concern”. The Bank of Montreal referred to the changes as “prudent, measured and responsible”.TD Bank Financial Group Chief Economist Craig Alexander commented extensively about the mortgage changes on BNN last week and provided some interesting analysis which expressed the changes in terms of a theoretically equivalent interest rate increase. Since the Bank of Canada continues to balance the competing interests of providing monetary stimulus (in the form of a very low bank rate) to the general economy while trying to slow the growth in housing related consumer debt, these regulatory changes (both sets announced last week), Mr. Alexander suggests, will have about the same effect as a 200 basis point rate increase would have. Such a rate increase would remove the general economic stimulus which is still needed - so cooling the housing market through mortgage rule changes allows the Bank of Canada to hold rates where they are and let the new mortgage rules work as if rates had been increased.
Commenting further in general support of the changes, Mr. Alexander suggested that the growth of household debt, although it has slowed recently, has significantly out-paced income growth. This has created conditions whereby the household debt to income ratio has grown to just over 150%. In the US, just before the crash of the housing market there, the household debt to income ratio reached about 160%. He also pointed out, however, that since about 20% of economic activity in Canada is housing related (including the purchase of furniture, appliances, décor etc) , that the medium term growth outlook for the Canadian economy will be adjusted slightly downward to reflect slowing activity in the housing sector as a result of the mortgage rule changes.
The changes will slow the market. For example, the Toronto Star reports that, according to CAAMP economist Will Dunning, over the past 16 months, 40% of Canadians who purchased homes, financed those purchases with mortgages amortized over more than 25 years. With amortizations for insured mortgages being capped at 25 years, refinances limited to 80% LTV and tougher maximum debt service ratios, fewer prospective homeowners will qualify, and of those who do qualify, if they were planning on extending their loan amortizations past 25 years, they will, effective July 9th, qualify for smaller mortgages.
The reaction of the real estate, mortgage and banking industries to these changes ranged from general agreement to only muted concern about a housing market downturn. This probably reflects the sentiment of general public opinion. Even though some of the most significant rule changes came as a surprise to the mortgage industry, considering the consistent messaging over the past few months from the Finance Minister and the Bank of Canada, these changes were easily foreseeable.