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Could Canada could slip into the same traps that hurt the U.S. economy in 2008-09? Some are sounding the alarm bells – at least on the housing front.


Clearly, Ottawa is worried about the debt levels being carried by the average household. Witness Finance Minister Jim Flaherty’s recent announcement that he was changing the maximum amortization on a government-backed mortgage to 25 years from 30 years.


The announcement was greeted with mixed reviews, including loud criticism from those who worry younger generations will have a significantly harder time being able to afford first homes.


But reducing the limit for mortgage amortization is not only good public policy – cooling the speculative real-estate sector without killing the home-construction industry – it is good for homeowners in general. Here’s why.


U.S. banks and lending institutions took part in two inappropriate activities in the U.S. housing and mortgage market prior to 2008, both passively allowed by the government in the hope of assisting low-income Americans to own their own homes.


First, banks were offering mortgages with low introductory interest rates that would later (one to three years later) rise to higher ultimate rates. Second, banks were offering mortgages at very high ratios to the value of the house (even up to 100 per cent). This was all fine – for both banks and home owners – so long as incomes and house values rose.


It all came to a thunderous halt in 2008.


As homeowners’ mortgages with low introductory rates came up for renewal, many could not afford the new higher payments that went along with the higher ultimate rates. Americans had to walk away from their loans, and therefore, from their homes – in droves.


At the same time, for those who had leveraged a very high percentage of their home value in their mortgage, the falling house prices meant that they now had a mortgage with an outstanding value that was larger than the value of the house. So, they too, simply walked away, handing the keys to their homes to the lending institutions.


This all snowballed into the exponential fall in American home values in 2008-09, and the accompanying loss in value of the mortgage assets held by the lending institutions – a very important piece of the global financial crisis.


In Canada, we are fortunate that our successive governments have always forced higher down payments for homes here than those required in the U.S. With the new limits on the amortization period, our government wants to dodge the American crisis. This is prudent, and safeguards the economy in general. But the new limits are also good for the individual home owner.


Let’s do some arithmetic. Consider a $100,000 mortgage. (Most mortgages are much larger, but you can get to the answer to your personal situation easily by multiplying by the size of your mortgage.) I will assume today’s five-year mortgage rate of 5.24 per cent.


If you take out a mortgage to be paid off over 30 years, your monthly payment will be $548.10. Over 30 years, you will pay a total of $197,316, including $97,316 in interest. If, however, you choose the 25-year mortgage, your monthly payment is $595.34 ($47.24 more a month). Over 25 years, you will pay a total of $178,602 – $78,602 in interest, just 80 per cent of the interest you would pay on the 30-year mortgage. Further, you will own the house debt-free five years sooner.


If interest rates rise, the arithmetic becomes more dramatic.


Consider a $500,000 mortgage at 6 per cent. If you choose the 30-year mortgage, you pay $2,974.12 a month for 30 years, a total of $1,070,683, including $570,683 in interest. Using a 25-year mortgage requires monthly payments of $3,199.03 ($224.91 more a month) for a total payment of $959,709, including $459,709 in interest.

In other words, for an extra $7.39 a day, you can own your house five years sooner and pay a whopping $110, 974 less in interest.


If a home buyer cannot afford an extra $7.39 a day in mortgage payments, should they be in the market? Aren’t we all really better off with the shorter amortization period?


The bottom line: The impact of this new legislation is less pain than pragmatism. For once, we should be thankful to our big brother in Ottawa.



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Finance Minister Jim Flaherty announced new rules for Canadian mortgages on Monday that he said will "protect the stability of the economy."


Flaherty's announcement comes on the heels of a recent warning from the Bank of Canada that Canadians' domestic debt burden is the highest on record.


The Monday announcement included three new rules for the mortgage industry that will come into effect March 18:


  • Mortgage amortization periods will be reduced from 35 years to 30 years.
  • The maximum amount Canadians can borrow to refinance their mortgages will be lowered from 90 per cent to 85 per cent of the value of their homes.
  • The government will withdraw its insurance backing on lines of credit secured on homes, such as home equity lines of credit.

"Taxpayers should not bear any risk related to consumer debt products unrelated to house purchases. Those risks should be managed by the financial institutions that originate and offer these practices," Flaherty said Monday.


It is the third time in three years that Flaherty has tightened credit rules while interest rates remain historically low.

The new restrictions are intended to ensure that Canadians don't slip into unmanageable debt, which could throw the economic recovery off the rails, he said.


"Today's measures are about our government continuing to protect the stability of the economy by ensuring lenders' practices are sustainable, which will in turn ensure Canadian families have increasingly secure and sustainable home ownership."


Flaherty targeted home-equity loans and lines of credit because some Canadians were using the money on consumer goods rather than to build equity into their homes, he said.


"They are used to buy boats and cars and big-screen TVs, and that's not the business mortgage insurance was designed for," he said. "Our measures will help improve the financial situation of households in Canada."


The Bank of Canada announced earlier this month that Canadians' domestic debt burdens had hit the highest levels on record. The bank said the ratio of household debt to disposable income has reached 148 per cent -- which is higher than in the United States.


The International Monetary Fund also recently warned that household debt is the number one risk to the Canadian economy. Canadian household debt is now at $1.4 trillion, while mortgage delay payments have increased by 50 per cent.


However, Flaherty maintained that Canada is not facing a debt crisis.


"We are responding to a situation that could develop," he told reporters.


"It's obvious we could have gone farther. We have not touched down-payment requirements, for example. This is intentional. We are trying to strike the right balance so that we do not create any sort of shock in the market, or any sort of dramatic pressure in the market."


Phil Soper, president and chief executive at Royal LePage, said the new measures "shouldn't have a significant impact on the housing industry itself."


"Policymakers and the minister needed to put an exclamation mark behind the concerns related to rising household debt and they did that with this," he told CTV's Power Play.


Jim Murphy of the Canadian Association of Mortgage Brokers agreed.


"The government is trying to find a balance between increasing household debt while at the same time trying to keep a healthy housing market," he said on Power Play.


The measures are equivalent to boosting interest rates by half a percent but are more specific, according to Douglas Porter, deputy chief economist at The Bank of Montreal.


"This is way a way of not affecting a lot of innocent bystanders, including the manufacturing and the tourism sector, by putting more upward pressure on the Canadian dollar," Porter told The Canadian Press.


Meanwhile Avery Shenfeld, chief economist at CIBC, said the new rules will have only a "marginal" effect on mortgage lending.


"It's the difference between somebody borrowing $200,000 and $180,000 or 190,000," he said. "More dramatic would have been to raise the down payment, which would have a larger impact on people's ability to finance their first home."


BNN's Michael Kane said Flaherty is clearly concerned that Canada's low lending rates have inspired people to borrow more than they would normally.


"What he is saying, and he reiterated this two or three times, is we see Canadians borrowing to the max at record low interest rates, and what he is afraid of is that when interest rates to start to rise...then you can get into a dangerous situation where you can't pay down your mortgage," Kane told CTV's Canada AM.



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