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New mortgage war could soften housing’s landing

Relax, Jim Flaherty. The big banks may damage their own bottom lines with another mortgage rate war, but they aren't going to derail your economic plans in the process. You already took care of that.

Canada's Finance Minister cautioned the banks to "engage in prudent lending – not the type of 'race to the bottom' practices that led to a mortgage crisis in the United States." He felt compelled to make the statement after Bank of Montreal – a laggard in the Canadian mortgage market that would dearly love to steal some market share from its big-bank competitors – dropped its five-year fixed mortgage rate to 2.99 per cent.

In doing so, BMO revived a bargain-basement rate that it introduced early last year, sparking a round of mortgage -rate cuts among banks that was blamed for overheating the housing market and ramping up the country's already excessive household debt levels. Household debt became the prime target for policy makers in both the government and the central bank, who see our collective dangerous overextension as a cancer in the economy that needs to be removed.

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But the biggest economic risk in excessive household debt, and mortgages in particular, is that they could lead to U.S.-style widespread defaults. And a lot has changed on that front since the last time BMO took us down the 2.99-per-cent road: Mr. Flaherty last summer instituted regulations that have been effective in keeping the most at-risk borrowers out of the mortgage market.

The government reduced the maximum amortization on government-insured mortgages to 25 years from 30, raised the bar on the income-to-debt-and-expenses test for mortgage applicants, and set a minimum down payment of 20 per cent on $1-million-plus homes. It's no coincidence that a slowdown in home sales began shortly thereafter.

With these restrictions ensuring the country maintains responsible levels of minimum quality on mortgages, slightly reducing already-cheap mortgage rates – while offering buyers the certainty of a five-year fixed term – is hardly going to dangerously raise defaults and seriously elevate broader economic risk. Indeed, mortgage-rate competition may spur a bit of demand in the cooling housing market, improving the chances of a soft landing in home prices – which would actually help the country's economic prospects.

For the banks themselves, a mortgage war doesn't sound like the happiest prospect in a year that is already shaping up as a weak one for profit growth. Last time posted rates were this low, bankers grumbled that they were actually losing money on mortgages. But the economy will do just fine.

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