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(Deborah Baic/The Globe and Mail)
(Deborah Baic/The Globe and Mail)

Debt worries trump home sales Add to ...

Finance Minister Jim Flaherty is betting that Canada's cooling housing market is strong enough without the fringe buyers who have been propping it up.

Housing has been key to Canada's economic recovery; prices are now higher than they were prior to the recession, and construction activity has been healthy. But home sales are now under pressure from the threat of higher interest rates, and Mr. Flaherty's latest move to curb 35-year amortizations stands to eliminate a number of potential buyers from the market.

Mr. Flaherty, citing concerns that Canadians are taking on too much long-term debt, said Monday the government would no longer insure mortgages that take longer than 30 years to pay off. Ottawa will also tighten the rules for existing homeowners who want to refinance their homes, by lowering the maximum amount Canadians can borrow to 85 per cent of the property's value, and will no longer provide insurance on personal credit lines secured by homes.

The impact on home prices is expected to show up quickly. BMO Nesbitt Burns deputy chief economist Douglas Porter said resale prices could drop as much as 7 per cent within the next 12 months because of the change to amortization lengths, as buyers who would have opted to spread the cost out over 35 years are forced instead to take out borrow less in order to keep their payments affordable.

"You can make the case that existing home owners will see their prices go down," he said. "You can go back to basic economics - it is the marginal buyer that really drives the market. If the buyer isn't there, the price has to drop until you get down to the next buyer."

Mr. Porter's forecast underscores the difficult balancing act that faced Mr. Flaherty in deciding on how to change the mortgage rules. Canadian household debt is at record levels, and much of that debt is related to real estate -- so any serious action on debt had to focus on mortgages. But at the same time, the government does not want to go too far, and risk triggering a broad housing correction that would hurt both consumer spending and the economy.

The average Canadian resale home sold for $344,551 in December. Assuming an interest rate of 4 per cent and the minimum 5 per cent down payment, a 35-year mortgage would have monthly payments of $1,441. Shortening the amortization period to 30 years increases the monthly payment about 8 per cent, to $1,555.

Some expect the government is on safe ground. Toronto-Dominion Bank expects that average house prices will slip by 2 per cent and that 20,000 fewer sales will take place this year because of the change. Craig Alexander, the bank's chief economist, said the housing market ended 2010 better than he expected, but the mortgage changes will keep a lid on growth.

"If you think of home prices over the last 10 years, that's not a big drop," he said. "And really, if someone can't afford 30 years instead of 35 then I'm not sure they should be buying a house anyway. So it cools the market a little bit, but I don't think it leads to significant weakness."

The changes come as banks are concerned about slowing loan growth. But some bankers and analysts believe the changes will remove only the riskiest borrowers from the market.

Still, those same customers helped fuel rapid growth in new mortgages for the banks since the government expanded amortizations to 40 years in 2006.

"It's fair to say that the changes being put in will work to slow loan growth by removing the marginal borrower from the market," said Robert Sedran, a banking analyst with CIBC World Markets Inc. "We had already expected that loan growth to slow - not because we necessarily expected some government mechanism to come into play - but simply because at the pace at which debt levels were climbing we didn't see it as sustainable."

The Canadian Real Estate Association said changes made by the government last year that made it more difficult for applicants to qualify for mortgages have already slowed sales, and that prices have leveled off across the country through the autumn. Randall McCauley, the group's vice-president of government relations, said the association is concerned that changing amortization rates is too blunt an measure for a market in transition.

"The amortization change is not a precise instrument - you can't make a change and know it will have a certain effect," said CREA vice-president of government relations Randall McCauley.

Mr. Flaherty acknowledged it's difficult to gauge the effect of the change, but said the danger of debt loomed too large to ignore.

"This is not arithmetically predictable, precisely," he said. "We expect some moderation in the market. We're taking these steps in any event now because of our concern about higher interest rates down the road."

The Canadian Association of Accredited Mortgage Professionals, which represents the mortgage brokerage industry, released a study late last year that showed mortgage debt in Canada surpassed $1-trillion for the first time in 2010. About 22 per cent of all new mortgages had amortization rates longer than 25 years, up from 18 per cent the year before.

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