Each decade has a defining moment. We all remember the World Wars, the Vietnam War, the Golden ’50s, the Marshall Plan, and the Wall Street Crash in 1929. The beginning of the 21st century will once again become a time of global financial crisis starting in the U.S., spreading through Canada, Europe, and Asia. It will be remembered as an era of deep crisis, Europe reformation, and an endless list of safety measures taken by our governments.
Governments are desperate. The crisis is getting out of control and whatever must be done, it must be done quickly. The clock is ticking. Even though our economic situation is not as bad as Europe’s, it’s not great either. Last week’s statistics reported the ratio of Canadian household debt to income continued increasing in the first quarter, to 152 per cent from the previous 150.6 per cent in the last quarter of 2011. This ratio is one of the key factors when it comes to determining domestic financial stability. It was the high level of household debt that started the European crisis in the first place. It’s always easier for governments to borrow money than it is for a private person. The high percentage of domestic debt and inability of households to pay instalments poses a serious threat to a country’s banking sector. Once the ratio gets above a certain level (it changes in response to several factors), bankruptcy might be inevitable.
To battle the rising household debt to income ratio, our government has decided to implement a few steps. These safety precautions and regulations should stop household debt from rising and later should also act positively toward its lowering. As part of the Government’s efforts to strengthen Canada’s economy and housing finance system, Jim Flaherty, Minister of Finance, announced further adjustments to the rules for government-backed insured mortgages on June 27, 2012. “Our Government stands behind the efforts of hard-working Canadian families to save by investing in their homes and their future,” said Minister Flaherty. “The adjustments we are making today will help them realize their goals, build on the previous measures we have introduced to keep the housing market strong, and help to ensure households do not become overextended. As just one example, the reductions to the maximum amortization period since 2008 would save a typical Canadian family with a $350,000 mortgage about $150,000 in borrowing costs over the life of that mortgage.”
What are the adjustments?
The Government has planned four safety measures for new government-backed insured mortgages with a loan-to-value ratio of more than 80 per cent.
Amortization Period Reduction
Jim Flaherty suggested reducing the maximum amortization period to 25 years from the previous 30 years. In a weekly credit outlook report published on Monday, William Burn and Andriy Stepanyants, Moody’s analysts, said shorter loan amortization periods should immediately cool home sales by requiring increased monthly payments. This step will reduce the total interest payments made on a mortgage and therefore help you to build up equity more quickly and pay off your mortgage sooner. The longest amortization period was set at 35 years in 2008 and then reduced to 30 years in 2011. Stronger debt service would be formed, as domestic borrowers will hold more equity in their properties. This step will create “an equity buffer the banks can access if necessary through the sale of the property and reduce the risk of unsecured credit exposure,” the Moody’s analysts said.
The next safety measure suggested by Jim Flaherty is to lower the amount of money Canadians can borrow when refinancing to 80 per cent from 85 per cent of the value of their property . This adjustment will promote saving through property ownership and motivate property owners to wisely manage borrowing against their homes. In most cases, property is the biggest investment and where the majority of savings lie, so the government decided to lower the refinance level.
Mr. Flaherty wants to remove federal government backing of HELOCs. They have become extremely popular in recent years and have been an important factor in the rise of overall debt. Mr. Flaherty said some banks were insuring their exposure to HELOC liabilities and he plans to cut this practice. Some of the loans are not used to create housing in Canada. They are used to buy cars, boats, big-screen TVs, or expensive holidays. Business insurance wasn’t designed to back these kinds of investments.
Household Debt Levels
Flaherty also lowered the maximum gross debt service ratio to 39 per cent and the maximum total debt service ratio to 44 per cent to get Canada Mortgage and Housing Corporation insurance . That means you can spend a maximum of 39 per cent of your gross household income on home expenses such as mortgage, property taxes, and heating, and a maximum 44 per cent of income on housing expenses and all other debt. Banks calculate the former by the sum of your mortgage payments and property taxes on a home loan divided by your income. The latter adds in other debt payments such as credit card debt. This step will help to better protect Canadian households that may be vulnerable to various economic shocks or increased interest rates.
The last change the Canadian government will implement is that government-backed mortgage insurance will not be available for those who are buying a property worth more than $1 million . One of the CMHC reports says only 5 per cent of properties are worth $550,000 and more are insured. The percentage lowers significantly as we move toward a home worth $1 million.
What Effect Will the Changes Have on My Life?
Don’t worry. The changes are moderate and therefore won’t affect you much. The Canadian government is worried that household debts might skyrocket and that would be a serious problem, so rather than waiting for what might and might not happen, they decided to implement a few adjustments to already existing regulations to prevent a greater disaster.
The adjustments made to the mortgage rules are perfect. Banks have been pushing clients towards the 25-year amortization already; the only change there will be from now on is that the measure will be official.
Flaherty said the new rules are part of an effort to “moderate behaviour” among Canadian homeowners and make them reflect before jumping into the housing market at the high end.
What do Business Analysts and Economists think About the Changes?
Robert Kavcic, economist, BMO Capital Markets
Reducing 30-year amortization periods to 25 years would amount to roughly a 0.9 per cent mortgage rate increase. This impact is bigger than the one we have seen already when the amortization dropped to 30 from 35 years. That change was equal to about a 0.6 per cent increase. It’s also important to keep in mind that the amortization adjustment won’t impact affordability in general, but rather those households taking a 30-year amortization, which according to the Canadian Association of Accredited Mortgage Professionals, made up 40 per cent of mortgages for purchase during the last year.
Jennifer Lee, senior economist, BMO Capital Markets
“Last quarter wasn’t good for the Canadian economy. Mr. Flaherty said the government needs to calm the condo market in a few Canadian cities on top of cooling the housing market in general. The four steps should prevent people from making an unwise investment and secure them better stability. Canadian retail sales fell 0.5 per cent — worse than the consensus view for a 0.3 per cent gain, and our call of a 0.1 per cent rise. It looks like the GDP is coming in at a modest +0.1 per cent, or flattish. In other words, the economy struggled to post any growth so far.”
Craig Alexander, chief economist, TD Economics
“We view the changes as a prudent decision that reacts on the increasing risks from consumer debt growth. Adjustments our government is taking should therefore take pressure off the Bank of Canada. Strong real estate markets in a sustained, incredibly low interest rate environment have fuelled the rapid personal debt growth in recent years. Since the imbalance mostly lies in real estate, monetary cuts and austerity measures would be an insufficient tool. Tighter regulations can therefore target the risk more directly.”
Tim Hockey, chief executive, TD Canada Trust
“Canadian household debt leves have come to a level that started to raise concern. Minister Flaherty’s decision to adjust mortgage rules as well as actions taken by OSFI take direct aim at the issue and they should have a significant moderating effect in the growth of Canadian’s debt levels.”