Posted by: Daryl & Wendy Ashby | February 27, 2010

Mortgage Reforms

And in recent years, people in their 20s have been asking for advice about buying condominium units to be rented out to others, using leverage almost exclusively through various loans and lines of credit set up by developers.

So the new mortgage regulations announced by federal finance minister Jim Flaherty, to take effect April 19, were needed to cool a gurgling Canadian housing market before it becomes a bubble.

They will improve the likelihood that homebuyers will be able to keep up payments when our record-low interest rates rise an expected three per cent within the next two years, and will make it tougher for speculators to drive house prices beyond the affordability of first-time home buyers in particular.

One change is that mortgage loans will be income-tested against the five-year posted interest rate, as opposed to the three-year rate currently used.

According to TD Financial, the current five-year closed variable rate is 2.25 per cent, but people must have enough income to pay the three-year fixed rate of 4.3 per cent, to prove they will be able to handle future rate increases.

Under the new rules, you will need to make enough income to pay the five-year rate of roughly 5.5 per cent. With the TD example, you will need annual household income of $68,838 rather than $59,626 to get a mortgage on a $337,000 home.

A second change is that people will be able to refinance only 90 per cent rather than 95 per cent of their property value. In other words, people with minimum down payments of five per cent will have to build the equity in their homes up to 10 per cent, when they will be able to take out no more than 90 per cent of the value of the property.

The third change, aimed at speculators buying “non-owner occupied properties purchased for speculation,” requires them to make a down payment of 20 per cent rather than five.

The latter move in particular could cool some action for realtors, who are already reeling from the warning by the federal Competition Bureau that the Canadian Real Estate Association has been limiting access to its Multiple Listing Service that generates billions of dollars each year in real estate fees.

Flaherty’s changes have been dubbed inappropriate by some people, who feel banks rather than government should have toughened lending practices. The response is that banks wouldn’t act individually because tougher restrictions would place them at a competitive disadvantage.

Other people think the government’s moves are inadequate, having expected Flaherty to raise the minimum down payment needed to obtain mortgage insurance from five to 10 per cent, and to decrease the amortization period that people can take to pay off a mortgage from 35 to 30 years.

But the new rules are a nice middle-of-the-road approach.

The Vanier Institute reported that national house prices reached $340,000 last fall, which is five times the average after-tax income of Canadian households, up from the long-term norm of 3.7 times.

The Institute added that the average household debt rose to $96,100 in the third quarter of last year, with a debt-to-income ratio of 145 per cent that is the highest since the think-tank began keeping records 11 years ago.

Furthermore, two-thirds of people aged 18 to 34 would be in financial trouble if their paycheque was delayed one week, and many of those are first-time homeowners.

The federal government and Bank of Canada face the dilemma of trying to keep housing affordable while making sure people who buy homes will be able to stay in them. Increasing down payments and reducing amortization periods for people buying homes to live in themselves would have made it tough for some people.

There are other ideas the government could have considered.

One way to help people cope with future interest rate hikes would be to have homebuyers pay a minimum of five-or six-per-cent interest, with the portion that is greater than the bank’s mortgage rate going into the homebuyer’s personal housing sustainability fund, to be drawn on when mortgage rates rise.

And a different way to cool speculative buying, which raises house prices, would be to no longer allow mortgage interest on “non-owner occupied properties” to be tax deductible. The current distinction generally does not allow speculators who “flip” houses and condos, selling them before earning rental income, to deduct mortgage interest, but investors with rental income are allowed to claim the tax break. However it’s a murky situation, one that has gone to the courts more than once.

The ability to deduct mortgage interest is why 40-year and interest-only mortgages, in which none of the payments go toward the principal, were loved by investors before being outlawed by the federal government in 2008.

So Flaherty may not be done on the mortgage front. Word is that should housing prices continue to climb, another shoe or two or three could drop.

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