Mortgages Rules For Canadian Home Buyers to Be Tightened

On July 9th, the Department of Finance moved to tighten Canada’s mortgages markets by announcing changes to the requirements for federally-backed mortgage insurance. The changes set minimum credit scores that home purchasers must meet to qualify for mortgage insurance on so-called ‘high-ratio mortgages’’ while restricting amortization terms to 35 years and requiring a minimum 5% down payment on mortgages insured through the Canadian Mortgage and Housing Corporation (CMHC) or other government-backed private mortgage insurers.

The tightening of Canada’s mortgage insurance rules, which will take effect on October 15th, is widely seen as a measure to further tighten Canadian mortgages market and forestall the credit problems that have crippled the U.S housing market. In announcing the changes, the Department of Finance characterized them as “a responsible and measured approach by the government to ensure Canada's housing market remains strong and to reduce the risk of a U. S.-style housing bubble developing in Canada."

Under the Bank Act, mortgages from federally-regulated lenders, including banks, credit unions, and caisses depots, must be insured where the value of the mortgage exceeds 80% of the value of the property or home being purchased or financed. Such high-ratio mortgages are insured primarily through the Canadian Mortgage and Housing Corporation, a federal Crown Corporation, but also through a handful of private mortgage insurers – Genworth Financial Canada, AIG and PMI Mortgage Insurance. The federal government guarantees the obligations of these mortgage insurers to lenders in the event of their not covering the costs of defaulted mortgages.

Effective October 15th, new federal rules will require that the loan-to-value ratios for federally-backed mortgages not exceed 95%, that amortization periods not exceed 35 years and that prospective borrowers have a minimum credit score of 620 and a debt service ratio (the percentage of income that goes to servicing existing debts and housing costs) of no more than 45%. The new rules will also require evidence of the reasonableness of the mortgaged property’s value and of the borrower’s source and level of income.

The new rule changes come at a time when Canadian real estate markets are already cooling off. Growth in housing prices showed a very moderate 1.1% year-over-year gain in May, according to the latest numbers from the Canadian Real Estate Association, as Canadian markets and consumer expectations have adjusted in response to the constant barrage of bad news about the worst U.S. housing market slump since the Great Depression and sobering forecasts about the state of a Canadian economy that is coming to grips with escalating energy and commodity prices.

The tightening of amortization periods and loan-to-value ratios will likely have a further dampening effect on Canadian housing markets, which already have sharply increased levels of resale and new home listings. However, this dampening effect may not be felt until after October 15th when the new rules come into effect. In the short term, the move to tighten mortgage lending standards could have the opposite effect – providing an impetus for Canadians to take the plunge into highly leveraged, no-money-down mortgages before the October 15th deadline.

(An October 15th implementation date was chosen to give home purchasers with mortgage pre-approvals the opportunity to exercise their options before the pre-approvals expire at the end of their usual 90-day term. Note, also, that the mortgages of existing home owners with high-ratio mortgages, amortization periods in excess of 35 years and substandard credit scores will be grandfathered under the new rules so that they will not be precluded from obtaining mortgage insurance when it comes time to refinance their homes.)

Industry feelings have been mixed about this latest move to ensure the solidity of Canada’s mortgages and housing markets. Most industry analysts applaud the move to ensure that Canadian home purchasers do not get sucked into the same speculative frenzy that fueled the meltdown of U.S housing prices when the sub-prime mortgage market unraveled. Other analysts seem to be expressing the view that this is a case of too-little-too-late or mere window dressing.

Derek Holt, Scotiabank’s vice president of economics, acknowledged that mortgage lending rules had been “modestly tightened” but noted that, “The changes are more about optics." Meanwhile, a more pessimistic analysis came from BMO Nesbitt Burn’s deputy chief economist, who observed that the rule change is “a bit like closing the barn door after the horse has already run down the road."

Canada’s mortgages and housing markets have not experienced the wild speculative bubble that erupted and burst south of our border, largely due to much more conservative lending practices here at home. Canadians were not privy to such innovative and speculative mortgage products as the so-called NINJA mortgages (“no income, no job, no assets), where borrowers could qualify for mortgages without adequate proof of income or employment that would enable then to afford the requisite mortgage payments, and only a small percentage of Canadians took out the sub-prime mortgages that scuppered U.S. markets. As a result, the percentage of Canadian mortgages in arrears are at the lowest levels – 0.27 per cent – they have been at since 1990, whereas Americans are facing mortgage foreclosures at a rate not seen since the Great Depression. This tightening of Canada’s mortgage insurance rules seem to be largely a pre-emptive move to reassure Canadian markets and ensure that Canadian home buyers do not go down the same path trodden by snake-bitten home buyers south of the border.