Canada: A look at Mortgage Lending Guideline Changes

June 29, 2012 -- The Honourable Jim Flaherty, Minister of Finance recently announced that he was making further changes to mortgage lending guidelines related to government-backed insured mortgages (i.e. loans subject to mortgage insurance offered by the Canada Mortgage and Housing Corporation or their private sector competitors).

The changes will take effect on July 9, 2012. I want to focus on two of these changes in particular:
The reduction of the maximum amortization period for insured mortgages from 30 years to 25 years; and
Setting the maximum gross debt service (GDS) ratio (i.e. the maximum share of gross annual income dedicated to mortgage principal and interest, property taxes and utilities) at 39 per cent.

These changes came as no surprise. The Finance Minister alluded to further tweaks to mortgage lending rules more than once over the past year. The deterioration of global economic conditions during the spring took interest rate hikes off the table for 2012. With this realization, Minister Flaherty took action to cool what, in his opinion, is an overheated housing market in some parts of the country.

All else being equal, the reduction in the amortization period will result in increased monthly mortgage payments. Let’s look at the calculation. During the first two weeks in June the average selling price for a home in the GTA was approximately $506,000. Assuming a five per cent down payment and a five-year fixed rate mortgage at 3.29 per cent amortized over 25 years, the monthly mortgage payment including the mortgage insurance premium would be $2,415 – about $260 higher than what the payment would have been for a mortgage amortized over 30 years.

Higher mortgage payments will prompt some households with tighter budgets to put their decision to purchase a home on hold. They will wait until they have saved a larger down payment and/or benefited from an increase in their income to offset the higher home ownership costs brought about by the new rules.

While some households will have to re-evaluate their decision to purchase a home, a household earning the average income in the GTA will continue to benefit from a substantial amount of flexibility from an affordability perspective. Under the new rules, using the same example as above, a monthly mortgage payment of $2,415 plus property taxes and utilities would account for 35 per cent of average household income before taxes (estimated at $103,500). This share is four percentage points below the new 39 per cent maximum specified by Minister Flaherty. This suggests that even with the added costs associated with the reduced amortization period, the average GTA household has room to account for a combination of price growth and interest rate hikes moving forward.

The bottom line is that the changes to mortgage lending guidelines represent a measured approach. Some households who were on the margin of affordability before these changes were announced will have to put their purchase on hold. This is not necessarily a bad thing. Moreover, the majority of households who were looking to purchase a home before Minister Flaherty’s announcement will still be able to do so affordably under the stricter rules.

In closing, I would be remiss not to point out the important contribution housing makes to the Canadian economy. A recent study undertaken for the Canadian Real Estate Association (CREA) found that each home sale in Ontario results in an additional $40,350 in spending on average. This type of economic impact cannot be ignored. In these times of global economic uncertainty, a buoyant housing sector has helped support Canadian economic growth. I would urge Minister Flaherty to bear this in mind before considering further interventions into the market.

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