Minister Jim Flaherty announced three new measures that are to come into effect April 19 th , 2010, that will affect all high-ratio insured mortgages. 

The move comes at a time when Canada’s booming housing market has sparked fears of a bubble, fueled by record-low interest rates.  Many economists are concerned some buyers have been lured into the market by today’s cheap credit, but are unprepared for the inevitable hikes in interest rates that are predicted to begin the second half of 2010. 

Subduing a Stable Housing Market

However, Mr Flaherty has downplayed the dire predictions, stating that government efforts to stimulate spending were intentional and effective, and that the measures are now meant to moderate the housing market before unsustainable expansion takes hold.

“Canada’s housing market is healthy, stable and supported by our country’s solid economic fundamentals,” said Minister Flaherty. “However, a key lesson of the global financial crisis is that early policy action can help prevent negative trends from developing.”

Government-insured Mortgages the Target

Currently, all mortgages of more than 80% of the home value - less than a 20% down payment – are considered high-ratio, and must be insured in case of default.  Most insured mortgages in Canada are currently covered by the Canada Mortgage and Housing Corporation (CHMC), a crown corporation; which means that the government is ultimately the payer of last resort on defaulted mortgages.

Fixed Rate Qualification for Insured Mortgages

The most wide-sweeping measure will affect how prospective homebuyers qualify for a mortgage.  Under the new rules, mortgage eligibility will be determined using the 5-year fixed posted rate (or the contract rate, where it is higher), regardless of which term the applicant will actually receive.  For example, even when selecting a 2-year variable term with posted rates of 2.5%, the applicant will need to show they can carry the same mortgage at the 5-year posted rate of 5.39% (currently). 

The five-year posted rate will be available weekly on the Bank of Canada website , under the 5-year conventional mortgage weekly option.

“This measure is intended to protect Canadians by providing them with additional flexibility to support mortgage payments at higher interest rates in the future,” read the Ministry of Finance press release. 

Room to Rise

In effect, insured mortgage holders will need to show they can afford higher payments than they will start out with.  For variable-rate mortgage holders, this offers a cushion should interest rates rise through the term, hiking their payments; and for fixed-rate mortgage holders, this ensures they do not meet with a nasty shock at renewal time, when rates may have risen dramatically.

All of which is designed to reduce mortgage default rates, protect government liability, and avert any possibility of the mortgage meltdown suffered in the US.

“Our Government is acting to help prevent Canadian households from getting overextended, and acting to help prevent some lenders from facilitating it,” commented Mr Flaherty.

Setting the Bar Higher?

Despite strong media reaction, however, the five-year qualification is not a great departure from current lender practices, which usually qualify a client using the 3-year fixed rate. 

And some lenders have already begun to skirt the requirement by putting together cut-rate five-year mortgage offers, offsetting ultra-low rates with reduced amortization terms and repayment options; with a low posted 5-year rate, these lenders will be able to take on borrowers that would not otherwise qualify under the current higher rates.

Limited Refinancing to Preserve Home Equity

The second measure to come into effect in April will be a 90% refinance limit for insured mortgages, down from the current 95%.  The move is meant to keep an ‘equity buffer’ in homes to allow for price variations, and to encourage homeowners to save money in their homes. 

The move may help to offset an anticipated price correction in Canada’s housing market, which has seen home values soar year-over-year. Those homeowners who are left with just 5% of their homes’ value at the price peak may find themselves in a negative equity situation when home prices fall, a scenario the government is keen to avoid amid job and investment volatility that may leave some mortgage holders unable to make their payments.

Consolidation Crunch

The downside is that many homeowners use refinancing as a means of consolidating expensive external debt into the much lower interest rates of a home mortgage, and the reduction in available equity may leave borrowers defaulting on other loans, which may ultimately affect their mortgage payments as well.

Bigger Down Payments on Rental Units

The third measure to take effect in April will have less effect on average homeowners, as it is directed at insured rental property mortgages – those properties that are not the primary residence of the borrower.  The measure will require a minimum 20% down payment for insured mortgages, a drastic increase from the current 5%, and CMHC insurance will no longer be available for multi-unit rental properties (excluding those that are owner-occupied).

The move is meant to reduce speculation by investors, and is predicted to have a dampening effect on the fast turnover of investment properties, as uninsured lenders generally charge higher rates.

Standardized Pre-Payment Penalties

In a separate agenda, the recently proposed federal budget also includes measures to standardize the mortgage pre-payment calculation, a move that is being hailed in all quarters. 

Currently, lenders each have their own formula for calculating the penalties associated with paying off a mortgage early, known as the Interest Rate Differential or IRD.  Current plans would force lenders to adopt a single formula, evening the playing field across the industry and giving borrowers a better understanding of the financial cost of early payouts.

“It is important that consumers have the information they need when making financial decisions, including when to pre-pay a mortgage. As such, the Government will bring forward regulations to bring greater clarity to the calculation of mortgage pre-payment penalties,” stated the budget plan.

The news from Statistics Canada is a welcome indicator that Canada, like the US, is bouncing back from the devastating recession that has sent economies tumbling worldwide.

This marks the strongest growth since 2000, well above the 4.1% growth predicted by analysts for the end of 2009, and soaring past third quarter gains of just 0.9%.  The US also announced strong recovery numbers, with its economy expanding by 5.9% for the same period.

Real Estate and Spending Drive Growth

Exports and real estate transactions played a key role in the recovery, with the housing market showing strong gains through 2009.   January’s figures showed sales increased 87% over the same period in 2009, and home prices are up an average 20% nationwide.  Consumer confidence has also increased, with consumer spending driving the economy upward.

This thanks to government spending, and affordable credit - the Central Bank slashed interest rates to historical lows through the economic downturn to stimulate spending, offered tax breaks for new homebuyers and alternatives means for establishing down payments.  As a result, buyers have crowded the market to take advantage of cheaper mortgages. 

The good news however comes with some fallout – the loonie has marked even stronger gains against the US dollar, threatening to flatten exports, the majority of which head south of the border.  Inflation also looms; with the stimulus effect achieved, the federal government will now be under pressure to raise interest rates to control inflation.

Interest Rates Still Low, but Hikes to Come

Thus far, the Central Bank has committed to keeping rates low, and the latest rate announcement has kept that pledge – rates remain firmly at a record-low quarter basis point.  However, should inflation rise, as it’s widely expected to do and soon, the Bank of Canada will have no choice but to raise rates to curb inflationary pressures.

Some analysts are predicting major hikes will be necessary to do this – as much as 50 basis points each announcement, through to midway next year.  Others say waiting too long risks sending inflation out of control, and the measures needed to rein it back in may be draconian, and quash a still-fragile economic recovery.

Record Deficit Calls for Government Spending Freeze

Despite the strong year-end gains, 2009 still saw economic contraction in Canada, with the economy shrinking 2.6% over the previous year, and government stimulus packages have created a major deficit that will need to be corrected.

Prime Minister Stephen Harper presented a budget in early March that would slash government spending and reverse the record deficit of $53.8 billion, or roughly 3.5% of GDP, by 2015.  However there are concerns that an abrupt end to government aid may further shock the embryonic recovery, which will likely face pressures from the necessary interest rate hikes.

Mr Harper has maintained his pledge not to raise taxes to relieve the deficit.

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