Flaherty tightens mortgage rules

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.

Discussion

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.

Conclusion

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.

Cheers,

Ben

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29 Responses to Flaherty tightens mortgage rules

  1. debunking says:

    What the hell was our goverment doing insuring HELOCs? Unbelievable!

    • I’d ask what they’re doing insuring ANY mortgages.

    • Grrr says:

      I read recently that there haven’t been many insured HELOCs offered in recent history. Maybe a pre-emptive strike to keep banks from offloading their worst risks on the government?

      Agree though. Insuring mortgages is bad enough, but HELOCs!!

    • rp1 says:

      Why not? It was a government sponsored credit party for everything else. In 2007 they insured zero-down 40 year mortgages for investment properties. And they would deduct 100% of estimated rent from the mortgage payment! Any idiot could borrow a million dollars!

      Or maybe we just let people state their income. I mean, that worked so freakin well in the US. All those realtors and construction workers making good money off real estate – we’ll secure loans for them to buy investment properties too! Nevermind that real-estate is 20% of GDP for some reason when it should be 8-12%. Nothing can possibly go wrong!

      So quite frankly, if the government wants to lend people money to buy TVs and shit, I say that’s a big improvement. At least big TVs only cost $1000. How many can you buy, five? That’s a hundred times cheaper than what we’ve been doing. Granite countertops?

      I have to say, in all the madness my favourite was the 2009 tax break where everyone went out and bought a jacuzzi. WOO HOO!! Canada’s economy is strong.

  2. Jordan says:

    The RE associations like to use the term “affordability” to describe the housing market — a perspective based on how much house a family can “afford” with a $X per month payment. Using this measure, housing in Canada (especially the big cities) just became significantly less “affordable”, at the stroke of a pen.

    When viewed in the context of what happened to the housing market in late 2010 (slumping sales everywhere), these new mortgage rules could very well trigger a cascade. Time will tell. April and May should be interesting.

  3. John in Ottawa says:

    The first of the 0% down, 35 and 40 year interest only mortgages come due for refinancing this year. I wonder how many won’t qualify.

    • buff_butler says:

      I believe unless you try to refinance you can continue on with their 40 year mortgage with their amazing ~5% loan paid off

      • John in Ottawa says:

        I’ve sent an email off to my banks mortgage specialist to try to get some answers related to this issue. I’ll post what I learn.

      • Leo S says:

        From what I’ve heard, the bank isn’t going to deny you your renewal, but you certainly won’t have any bargaining power, so they can stick you with their posted rates.

        If you don’t qualify at another bank for a new mortgage, you wont have much choice but to take what they give you or sell the place.

        Also, love the blog Ben, great info every time. Only one minor nitpick though, could you try to post your graphs at higher resolution? Sometimes (like the last graph on this post) is almost impossible to get any info from because I can’t read most of the text on it.

      • buff_butler says:

        “you certainly won’t have any bargaining power, so they can stick you with their posted rates.”

        Leo thats actually an excellent point, thanks for looking into that for us.

      • jesse says:

        I thought CMHC insured mortgages were transportable. Why would they not be now?

  4. buff_butler says:

    The interesting part of this is that it guarentees that prices will atleast remain flat; so with all the negative cashflow properties that require outside capital to sustain themselves will incur a loss this year.

    • HHV says:

      How do you figure this move that makes it harder for first time buyers to get into the market “guarantees” prices will remain flat?

      • buff_butler says:

        You caught me 😛 theres no real guarantee first off.

        So if we work through the math this has reduced purchasing power effectively by ~7% for the average purchaser. Additionally we are at the near top of our affordability range in most cities; Ben made a great point about this before. In finance there are a lot of ratios that typically just don’t break down throughout time and this is one of them; at least without a good reason.

        If you have time do a graph of LA or San Fran, you’ll see that prices were in their historic affordability range before the crash as well (I’m not referring to real prices but real affordability).

      • ridiculous says:

        Much of the value many people see in real estate is associated with climbing prices, in the same way many people value Apple or any other growth company on the stock market. Once the growth stops, the perception of the asset changes and valuation drops. A stock valued at 25x earnings with growth priced in can quickly fall to 10x earnings or below if growth levels off unexpectedly. In other words – when the likelyhood of future price increases decreases, all a cash negative RE investor will be left with is negative cash flow, which should lead more people to sell. (If they ever want to retire, at least).

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  6. Ralph Powers says:

    Further to what Leo S said, (about mortgagees not having bargaining power) this is also going to hammer the mortgage brokers. They won’t be able to move their ‘clients’ from one FI to another at renewal time because to take it to another FI they’ll have to qualify at the new higher standards.

    • jesse says:

      Really? Come on if this is true post a citation. CMHC mortgages are transportable and that doesn’t change with the new rules: old loans amortize the same as before and are not recast on renewal. As far as I can tell. It’s on CMHC’s website.

    • jesse says:

      It seems like some mortgages are assignable while others aren’t. There is some ambiguity on this that CMHC should clarify. Good point buff and Ralph.

      I find it concerning the issue of re-assigning an insured mortgage is so obfuscated. Buyer beware.

  7. John in Ottawa says:

    I decided to sleep on it before commenting, but I still cannot see why Flaherty has reduced the amortization period to 30 years from 35. He does a nice job of spinning the move as an altruistic attempt to save home purchasers interest costs, but that isn’t it.

    People buy houses primarily based on affordability, not an honest assessment of minimum needs. In other words, for the most part they buy all the house they can.

    If prices stay the same, Flaherty has just reduced the number of eligible buyers at the margin. Not the extreme margin as Ben suggests, just the margin. If the number of eligible buyers is to remain the same, prices must fall about 4.5% to accommodate the higher monthly costs.

    I can appreciate what Flaherty has done with HELOCS, regarding insurance. But by reducing the amortization period again, I think Flaherty has just pulled the rug out from under consumer spending and house prices at the same time. Time will tell. At a time when inflation is not a major concern, this was, by definition, a deflationary move.

    • jesse says:

      I’d argue doing nothing is even more deflationary in the long term.

    • backwardsevolution says:

      John in Ottawa – “At a time when inflation is not a major concern…”

      What? There’s been no inflation in housing? Are you completely mad?

      We need to get back to 20% down/25 year amortizations. Why? When a couple who has saved nothing decides to buy a house, they will see they have to actually “save” (just like what used to happen) up $60,000.00 on a $300,000.00 condo box. That’s when the wheels might grind and they might say, “Wow, we have to actually save a ton of money to buy this property; it’s not worth it.”

      Of course it’s not worth it. That’s when prices will come back down to the mean, which they always do (aside from when the government steps in to help the real estate/banking industry).

      When the condo comes back down to earth, say $150,000.00, they can save for a few years (just like used to happen) and then buy with $30,000.00 down. That’s still a lot of money, but do they want a house or an investment? Are they looking for a roof over their heads or are they speculating? Let’s see them have a stake (which only can be felt when you have to save hard) in their future. Buck up and put YOUR OWN money on the line.

      That has been the problem. When you reduce mortgage rates to nothing, insure banks against losses through CMHC (taxpayers), give a mortgage to anyone who can fog a mirror, who struggle to meet their payments even at these ridiculously low rates, will it really be a surprise when it all comes undone, they’re underwater, they can’t pay?

      What a complete illusion. I am sickened by the greed, which will come back to haunt over and over again.

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