The New Mortgage Rules

Take from Ratesupermarket.ca

A need for change

Since 2008, the recession has hit some areas of the economy hard, among them business investment and exports. But, thanks to record low interest rates, Canada’s housing market has helped drive the economy through the worst of it. The problem: Canadian’s household debt has risen to record levels and this has many economists worried about the future of the economy.

According to some experts, for the past 20 years Canadian’s debt-to-income ratio has been climbing steadily – much faster than disposable income. Since the start of the recession, the number of households that have fallen behind on their mortgage payments by three months or more is up by nearly 50 per cent. In order to manage high-interest debt, like that found on credit cards, some homeowners find themselves refinancing to free up money.

Financial experts advise homeowners, warning that total housing expenses should not swallow up more than one-third of the total household income. Yet, according to a BMO mortgage survey, even though two in three homeowners say that they would be able to handle it if interest rates were to rise, some 18 per cent say that they might be in trouble. The consequences for the homeowner are serious and could result in loss of home, or even bankruptcy.

As a result of these concerns, Finance Minister Jim Flaherty announced a series of mortgage rule changes in January of this year. He said that the amendments are meant to address the growing concern about the substantial increase in household debt in Canada, but more specifically they are meant to reduce the total interest payments people end up paying with longer amortization periods.

What are the new rules?

After the new rules were announced, the government gave the industry 60 days to adapt.  The new system will take place this week on March 18.

The rule changes are as follow:

1. Ottawa will no longer insure home equity lines of credit.
2. For homes purchased with less than 20 per cent down, the maximum amortization period will be cut to 30 years from 35 years.
3. A tightening of mortgage-backed lines of credit mean that Canadians will only be able to borrow up to 85 per cent of the value of their homes. This is down from 90 per cent.

What do they mean for homeowners?

A shorter amortization period has its pros and cons. Some homeowners are attracted to lower monthly payments, but might not realize that they are paying substantially more in interest over time.  For those who put a down payment of less that 20 per cent, this also means higher monthly payments. Under the current rules a $300,000 mortgage at 5 per cent, with a 35-year amortization would total $1,514 monthly. Under the new rules, the monthly total comes to $1,610, a difference of $96. Doesn’t seem like a big deal, does it? Calculate the total savings over the lifetime of the mortgage and the average homeowner saves $56,139.

The reason behind tightening mortgage-backed lines of credit is understandable as well. Many homeowners are refinancing, using home equity to get out of credit card debt. Although the practice of using lower interest debt to pay off higher interest debt is a reasonable solution, it only works if you are able to maintain a certain amount of equity in your home.  Some homeowners refinance every couple of years and actually end up owing money when they sell.

For future homeowners, the new mortgage rules could have the effect of pricing them out of the market altogether, but it’s likely that they aren’t as financially ready for homeownership as they could be.

Some experts, however, don’t see the future as quite so bleak. Many first-time homeowners choose 25-year amortization periods, rather than paying the extra interest over the years and are prepared to pay down payments over 20 per cent in order to avoid mortgage insurance payments as well. In Canada, those who purchase a home with a down payment of less than 20 per cent of that home’s value are required to purchase government-backed mortgage insurance through companies such as Canada Mortgage and Housing Corporation. This can add to the monthly cost of owning a home.

While the government believes that the new rules will have the effect of lessening Canadians’ financial burdens in the long run, some economists believe that rising mortgage rates are a deeper threat to the market. Rising interest rates would make monthly mortgage payments more expensive, leaving those who took on too much “cheap debt” in trouble.

Although there’s no easy way of preparing for every financial hiccup one might experience in the future, it’s always good advise to spend within your means. The new mortgage rules, in particular the refinancing rule, will help keep Canadians on track with their finances.