Mortgage Rules: It’s a Good Start

February 16th, 2010 by Potato

The government, in a bit of a surprise move today moved to tighten mortgage lending rules to help reign in the housing bubble here (which, for political reasons they can’t actually admit exists). I don’t mean that rules of this sort coming into play were a complete surprise, indeed there has been much speculation and hope that some sort of tightening would be employed in the budget. Just that it was a surprise to come today when the federal budget is less than a month away. To me that’s an actions-speak-louder-than words type thing, that these rules couldn’t wait until the spring frenzy.

Anyhow, on to the new rules:

The weakest in my opinion is the new rule that refinancing can only take one down to 90% equity. It’s to help prevent people using their homes’ rising valuations as ATMs, but I have trouble seeing how it might actually prevent a bubble — just maybe lessen the pop since it makes it a little harder for existing homeowners to put themselves underwater alongside new homebuyers.

The way the banks and the CMHC will calculate your debt service ratios (i.e.: how much house you can afford) will change slightly, so that now you must be able to afford payments at the 5-year fixed rate instead of the 3-year one. Since the 5-year rate is currently a few hundred basis points higher than the variable-rate, it will help protect people from themselves, and ensure that a small jump in rates won’t cause people to have to leave their homes. Supposedly, many people in this rate environment are taking 5-year mortgages anyway, but I have to suspect that this is going to screen out at least a few first-time buyers whose real estate agents have sold them on a price point based on the “monthly carry” at 3% or some ridiculous temporary interest rate. Personally, I’d like to see this as an even more conservative rule: i.e., ensuring people could afford their houses if rates shot up to beyond the current 5-year rate — perhaps an arbitrary 8 or 10% rate, or perhaps the high water mark for the last decade (though that can also lead us towards fooling ourselves in long periods of declining rates).

The last point is the one that I think is the most needed, and will do the most to stem speculation: people buying real estate other than as their primary residence, i.e., speculators, must put down at least 20%. So anyone that’s been investing in multiple condos in Toronto because you only need 5% to get your foot in the door will find that they have to have some money to buy. Unfortunately, it’s probably also the hardest to enforce — after all, if you search the blogs of the speculators, you’ll find they seem to skate around the other principal residence rules in efforts to make their flipping gains tax-free. I’m sure they’ll argue that they intend to live in each of their units, but had to buy the next three before selling the first… Depending on how this rule is implemented, it could start deflating the condo market quite quickly: if people who signed up for a dozen pre-construction units two years ago for completion this summer find they now have to have 20% down at the close, they may be in a terrible rush to sell. If existing contracts aren’t affected though, then it will still take some time for the hot air to work its way out of the system — which is probably how this will be implemented.

So, some quick (slightly inaccurate) numbers:

Let’s say you’re a couple with a gross income of $100k. 32% of that monthly is $2666/mo — that’s the guideline maximum for your mortgage payment, heating costs, and property tax. Let’s assume your heat and property tax are a fixed $300/mo, which leaves $2366/mo for the mortgage. With a 35-year amortization and a 3-year posted rate of 4%, you can afford a morgage of about $534k. At the 5-year posted rate of 5.4%, that maximum possible mortgage drops to $446k. A decline of ~17% in the maximum house you can buy. Depending on how many people were actually at the limits of their debt service ratios, that could undo the massive run-up that we had in 2009 as a result of the low interest rates.

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