Flaherty tightens mortgage rules again
The tightening of mortgage rules that was expected in the next budget arrived ahead of schedule. Jim Flaherty, Minister of Finance, today announced three changes to mortgage insurance rules which will come in to effect on March 18, 2011:
1) Reduce maximum amortization to 30 years from the current 35 years. This will have the effect of raising the monthly payment slightly, but significantly reducing the total interest paid over the life of the mortgage.
2) Reduce maximum refinancing to 85% of home value from the current 90%.
3) Withdraw government insurance on non amortizing home equity lines of credit.
The changes were largely expected, though earlier than most had anticipated. Let’s look at all three changes and assess their potential impact on the housing market and broader economy.
1) Amortization changes:
The new rule change will certainly squeeze the pool of new buyers, but only at the extreme margins. The change in monthly payments between a 35 and 30 year amortization is typically between 5 and 10 percent….significant, but certainly not massive.
However, for perspective, let’s refer back to CAAMPs most recent ‘State of the Mortgage Market’ publication for some insight on just how this might affect the entry of new home buyers:
In 2010, 30% of all new mortgages were originated with 35 year amortizations.
The problem with this data is that it aggregates all new mortgages. The important stat would be the percentage of first time home buyers who made use of 35 year ams. As the housing market is entirely dependent on the continued influx of new home buyers, this is of extreme importance.
Logic would suggest that pre-existing home owners looking to sell and buy a different home would get mortgages with lower loan-to-value ratios given the equity they would bring from their current home. It would also be logical to assume that these home owners would get lower amortization mortgages than first time buyers. This is all anecdotal but it certainly suggests that the percentage of first time home buyers making use of 35 year ams is likely higher than reported by CAAMP. As an aside, my own observation is that 35 year ams are far more common among recent first time buyers than suggested by the CAAMP data.
However, there is also a more ominous piece of data buried in the report. It indicates that 16% of survey respondents indicated that they could not manage an extra $300 increase in mortgage payments. Given our tendency to represent our finances as being healthier than they are, either knowingly or unknowingly, I would suggest that this percentage is likely higher than reported. Also, as with the previous point, this data will most represent the newest home buyers.
Taken collectively these facts certainly suggest that the new mortgage rule changes could squeeze the pool of new home buyers more than anticipated. TD calculated that the new mortgage changes might reduce sales by 20,000 units this year and cut 2% off the average price.
Let me add to this that it will bear watching how both sales and inventory react to this news. There may be an expected jump in sales as those buyers at the margin seek to take advantage of the favourable rules before they are changed. However, it may also spur those thousands of home sellers who pulled inventory off the market in near-record numbers through the latter part of 2010 to re-list over the next month to try to capture this last bounce in demand.
The big story of 2011 was already set to be the ‘Mexican standoff’ between buyers and sellers, with both groups on a now 6 month strike. These new rule changes only thicken that plot.
2) Refinancing changes:
TD calculated that home owners who refinanced with less than 15% equity represented only 1/10th of the total volume. As such, it will once again only affect the ability of home owners at the extreme margins to access refinancing.
However, it will have an effect on consumer spending as that credit will no longer be available for debt consolidation, home improvements, and vehicle purchases, the three largest uses of home equity withdrawals, though the total reduction in demand directly attributable to this new rule shouldn’t be huge.
3) Changes in government insurance on non-amortizing HELOCS
HELOC growth is certainly a huge concern as it has massively outpaced mortgage growth in the past decade.
However, only a handful of institutions actually insure their HELOC portfolio. In addition, this should not affect total HELOC growth as the loans can simply be structured as an amortizing loan rather than a revolving loan. I don’t see this new rule change as a major impediment to the growth in HELOCs.
By far the more important factor will be house price appreciation as it is directionally correlated with HELOC growth. Even the modest decline in house prices forecast by the big banks (2-12% depending on the institution) will have the effect of weakening HELOC demand and straining consumer spending. As the following graph indicates, when housing peaked in the US, home equity withdrawals (HELOCs) declined significantly and have since turned negative meaning people are actively paying them off or defaulting on them.
If/when home prices normalize, this same phenomenon will be the most significant driver of weak economic growth in Canada as it saps consumer spending which itself is 65% of GDP.
While the new rule changes will curb entry into the housing market for marginal buyers, they certainly don’t represent massive changes that on their own will result in a price cascade. However, there are always unintended consequences to any government policy. This one will be no different. While on their own they do not represent a major overhaul, they add one more straw to the back of an already-strained camel.