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Low rates could spur mortgage rule changes

  Sep 8, 2011

With Canadian interest rates now on hold for some time to come, the government may move to tighten mortgage rules again to keep the already hot housing market from bubbling over, says the chief economist of Canada’s biggest bank.

“As we go forward in an environment of lower rates for longer now, we may see another round of mortgage rule tightening,” said Craig Wright, chief economist at RBC Financial Group during a panel discussion on Canada’s economy at the Economic Club of Canada.

Following Wednesday’s decision by the Bank of Canada to keep its key lending rate unchanged at 1%, it is now widely expected that interest rates will stay at uncommonly low levels well into 2012 or longer if the global economy continues to deteriorate.

Mr. Wright believes that Canada’s fast-growing housing market, which resulted in an impressive 6% increase in building permits last month, will start to slow in the months ahead.

Several factors boosting mortgage activity in the first half of the year, including the HST in Ontario and B.C., are becoming less important catalysts, he said, while consumer confidence about the economy and overall affordability are growing headwinds.

In a cooling scenario, he said it is unlikely that more stringent mortgage rules will be forthcoming. However, if a moderate slowdown doesn’t take place as expected, it becomes increasingly possible that regulatory changes, including shorter amortization periods and an increase in the amount of mortgage insurance required will be needed in the future in order to curb a growing appetite for credit.

“Lower rates make debt more attractive but that is countered by the confidence shock that we are all feeling towards the economy,” he said. “So the jury is still out but [Ottawa] may end up feeling the need to tighten a little bit further.”

Part of the run-up that Canada has seen in personal debt levels over the past decade has largely been driven by mortgage growth that has coincided with easier access to credit.

In more recent years, concerns about the rising levels of household credit has prompted Ottawa to tighten its mortgage rules and this past January Finance Minister Jim Flaherty announced three new changes:

The first reduced the maximum amortization period to 30 years from 35 years for government-backed insured mortgages with loan-to-value ratios of more than 80%; the second lowered the maximum amount Canadians can borrow in refinancing their mortgages to 85% from 90% of the value of their homes; and the last adjustment withdrew government insurance backing on lines of credit secured by homes.

Mr. Wright points out that even with these tighter measures, mortgage rules are still much looser than they were ten years ago.

He noted that the required downpayment used to be 10%, compared to 5% now, while amortization was previously a maximum of 25 years. Furthermore, the qualification for mortgage insurance had been 25% and is 20% today.

“There is still, if need be, some room to move back to where we were,” he said. “We may not need to go back there, but there is an option if we don’t see any moderation in debt going forward.”

While Canada’s mortgage rules may be looser than was previously the case, they have remained much more stringent than U.S. regulations governing home loans, said Sherry Cooper, chief economist at BMO Capital Markets. Because of that, she considers Canada’s housing market to be in much better shape than it would be otherwise.

“Not only did Canada dodge the sub-prime problem, but when you look at the aggregate of equity in homes among Canadian households it is much higher than in the United States,” she said during the panel discussion.

She is also encouraged by the fact that Canada’s home-ownership ratio is much higher than it is south of the border and statistics that show Canadians typically pay off their mortgages prior to retirement.

While there has been an inordinate rise in house prices in some regions of the country, notably in Vancouver and to a much smaller degree Toronto and Calgary, which already seen a correction, she doesn’t believe a massive housing bubble is going to burst, largely because much of the demand for Canadian homes is coming from foreign investors who aren’t reliant on mortgages to make their purchases.

“As anyone who has been involved in the housing market, there seems to be tremendous interest in our markets by foreigners who want to diversify their investment and see Canadian real estate as a positive and affordable — believe or not — opportunity,” she said.

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