On Monday, January 17, 2011, Jim Flaherty, Minister of Finance along with Christian Paradis, Minister of Natural Resources announced new mortgage rules aimed at reducing some of the risk in the Canadian mortgage market after mounting concerns over rising consumer debt levels in Canada.
“Canada’s well-regulated housing sector has been an important strength that allowed us to avoid the mistakes of other countries and helped protect us from the worst of the recent global recession,” said Minister Flaherty.
With household debt in Canada reaching a record 148% of disposable income in third quarter of 2010, exceeding the US level of 147%. The government wants to ensure there is no US style mortgage meltdown in Canada as interest rates are anticipated to rise in 2011.
The rules are aimed at promoting responsible lending and borrowing in Canada while encouraging people to increase their home equity.
Three new mortgage rules were announced including:
- Reduce the maximum amortization period to 30 years from 35 years for new government-backed insured mortgages with loan-to-value ratios of more than 80%.
- Effective March 18, 2011
- This will significantly reduce the total interest payments Canadian families make on their mortgages, allow Canadian families to build up equity in their homes more quickly, and help Canadians pay off their mortgages before they retire.
- Lower the maximum amount Canadians can borrow in refinancing their mortgages to 85% from 90% of the value of their homes.
- Effective March 18, 2011
- This will promote saving through home ownership and limit the repackaging of consumer debt into mortgages guaranteed by taxpayers.
- Withdraw government insurance backing on lines of credit secured by homes, such as home equity lines of credit, or HELOCs.
- Effective April 18, 2011
- This will ensure that risks associated with consumer debt products used to borrow funds unrelated to house purchases are managed by the financial institutions and not borne by taxpayers.
“The prudent measures announced today build on that advantage by encouraging hard-working Canadian families to save by investing in their homes and future,” added Flaherty.
“The economy continues to be our Government’s top priority,” continued Minister Paradis. “Our Government will continue to take the necessary actions to ensure stability and economic certainty in Canada’s housing market.”
This move is widely viewed as a measure to influence the Canadian mortgage market and Canadians debt levels without resorting to interest rate hikes. It gives the Bank of Canada and Mark Carney much more flexibility and allows him to keep Canadian interest rates low thereby putting less pressure on the overall Canadian economy.
The government is implementing a policy that will affect a subset of borrowers instead of the entire economy.
The 2011 Mortgage Changes in Detail:
1) Change Maximum Amortization Period to 30 YEARS:
A typical mortgage in Canada will have a term of five years or less at which time it can be renewed with a specific amortization period in which the entire mortgage must be paid off.
The new rules which come in effect on March 18, 2011 (only applies to mortgages with less than a 20% down payment) will reduce the maximum amortization period from 35 years to 30 years resulting in a moderate increase in the monthly payment along with a significant reduction in the total interest paid over the amortization period.
A typical $300,000 mortgage with a 5% interest rate will see monthly payments increase by $97.00 per month from $1,504 (35 year amortization) to $1,601 (30 year amortization) and result in a total $55,404 interest savings over the life of the mortgage.
2) Lower Maximum Refinancing To 85% Loan-to-Value Ratio:
Canadian borrowers can refinance their mortgages to increase the amount of the loan secured against their home.
The new rules which come in effect on March 18, 2011 will reduce the limit on refinancing from 90% to 85% of the value of the home. As refinancing a mortgage usually lowers the borrower’s equity in their home, reducing the maximum loan-to-value ratio on refinancing will encourage Canadians to keep more equity in their home.
A typical home valued at $300,000 will allow a homeowner to access up to $255,000 at the new 85% loan-to-value ratio, while previously they would have been able to get up to $270,000 at the 90% rate. The changes will increase the remaining home equity by an additional $15,000.
3) Withdraw Government Insurance on Non-Amortizing Lines of Credit Secured by Homes:
Currently a line of credit secured by the borrower’s home, such as a home equity line of credit, is limited to a maximum of 80% of the value of the home.
There has been a substantial increase in the credit available to Canadians through this type of secured line of credit over the past several years, and it is an important factor in the rise in overall household debt. These loans are generally non-amortizing, which means that borrowers are not required to make regular payments on the principal amount of the loan.
Moreover, these loans are almost exclusively variable rate products, which expose borrowers to the impact of rising interest rates.
While regulated lenders are not required to obtain insurance on lines of credit secured by homes at the time of origination, they may choose to obtain insurance after origination through what is known as “portfolio insurance,” where secured lines of credit are pooled into a portfolio and then insured by a mortgage insurer. At the time of insurance, the benefit of the portfolio insurance is to the lender by facilitating funding, rather than to the individual borrower. Other options exist for lenders to fund their secured lines of credit.
Many lenders now offer multiple loans or a multi-segment loan secured against a borrower’s home. If a loan or a segment of a multi-segment loan is in the form of a revolving line of credit that does not amortize over time, it will no longer be eligible for government-backed insurance. However, with established scheduled principal and interest payments, a loan will continue to be eligible for government-backed insurance, provided it meets the underwriting standards set by the mortgage insurer.
Withdrawing government insurance backing on these non-amortizing products is consistent with the Government’s objective of supporting the long-term stability of Canada’s housing market.