January 19, 2011 Changes to Mortgage Rules
Bank of Canada maintains overnight rate target at 1 per cent
| FOR IMMEDIATE RELEASE 18 January 2011 | CONTACT: Jeremy Harrison 613 782-8782 begin_of_the_skype_highlighting 613 782-8782 end_of_the_skype_highlighting |
Bank of Canada maintains overnight rate target at 1 per cent
OTTAWA –The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1 per cent. The Bank Rate is correspondingly 1 1/4 per cent and the deposit rate is 3/4 per cent.The global economic recovery is proceeding at a somewhat faster pace than the Bank had anticipated, although risks remain elevated. Private domestic demand in the United States has picked up and will be reinforced by recently announced monetary and fiscal stimulus. European growth has also been slightly stronger than anticipated. Ongoing challenges associated with sovereign and bank balance sheets will limit the pace of the European recovery and are a significant source of uncertainty to the global outlook. In response to overheating, some emerging markets have begun to implement more restrictive policy measures. Their effectiveness will influence the path of commodity prices, which have increased significantly since the October Monetary Policy Report (MPR), largely reflecting stronger global growth.
The recovery in Canada is proceeding broadly as anticipated, with a period of more modest growth and the beginning of the expected rebalancing of demand. The contribution of government spending is expected to wind down this year, consistent with announced fiscal plans. Stretched household balance sheets are expected to restrain the pace of consumption growth and residential investment. In contrast, business investment will likely continue to rebound strongly, owing to stimulative financial conditions and competitive imperatives. Net exports are projected to contribute more to growth going forward, supported by stronger U.S. activity and global demand for commodities. However, the cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance are restraining this recovery in net exports and contributing to a widening of Canada’s current account deficit to a 20-year high.
Overall, the Bank projects the economy will expand by 2.4 per cent in 2011 and 2.8 per cent in 2012 – a slightly firmer profile than had been anticipated in the October MPR. With a little more excess supply in the near term, the Bank continues to expect that the economy will return to full capacity by the end of 2012.
Underlying pressures affecting prices remain subdued, reflecting the considerable slack in the Canadian economy. Core inflation is projected to edge gradually up to 2 per cent by the end of 2012, as excess supply in the economy is slowly absorbed. Inflation expectations remain well-anchored. Total CPI inflation is being boosted temporarily by the effects of provincial indirect taxes, but is expected to converge to the 2 per cent target by the end of 2012.
Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. This leaves considerable monetary stimulus in place, consistent with achieving the 2 per cent inflation target in an environment of significant excess supply in Canada. Any further reduction in monetary policy stimulus would need to be carefully considered.
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Flaherty Details New Mortgage Rules
Finance Minister Jim Flaherty announced Monday that new federal rules will reduce the maximum amortization period to 30 years from 35 years for government-backed insured mortgages with loan-to-value ratios of more than 80 per cent.
Secondly, Ottawa will lower the maximum amount Canadians can borrow in refinancing their mortgages to 85 per cent from 90 per cent of the value of their homes.
Thirdly, Ottawa will withdraw government insurance backing on lines of credit secured by homes.
Though longer amortization periods reduce monthly payments, they greatly increase the amount of interest paid over the life of the mortgage and make it harder to build up equity.
The average Canadian resale home sold for $344,551 in December. Assuming a five-year mortgage at 4 per cent interest, and the minimum 5 per cent down payment of $17,227, a 35-year mortgage would have monthly payments of $1,441. Shorten the amortization period to 30 years, and the monthly payment increases to $1,555.
At a news conference in Ottawa, Mr. Flaherty said the measures will encourage Canadians to save more through home ownership. He said they will also reduce the exposure of Canadians to financial risks.
Mr. Flaherty said his concern is not Canada's mortgage default rate - which is less than 1 per cent. Rather his concern is those who are borrowing as much as possible.
"We're seeing people borrow to the max, and borrowing to the max at low interest rates," he said. "Most Canadians are not doing that."
Mr. Flaherty predicted the measures will have "some moderating" impact on the housing market.
He said the changes will not take effect imediately because of a requirement to give the industry 60 days notice before making policy changes of this nature.
He said past experience suggests there is no need to fear a rush on 35-year mortgages before the new rules take effect.
In addition to cutting mortgage terms, Ottawa is taking action to reduce the rapid rise in home equity lines of credit, or HELOCs. The government will do this by clamping down on the insurance that Canada Mortgage and Housing Corp. offers to the lines of credit.
Home-equity lines of credit and loans have surged in Canada, rising at almost twice the pace of mortgages over the past decade to account now for 12 per cent of overall household debt.
The third measure that will reduce how much Canadians can draw on their home equity. Last February the Finance Department announced that it would lower the maximum amount Canadians could withdraw in refinancing their mortgages to 90 per cent from 95 per cent of the value of their homes. It is now reducing that maximum to 85 per cent from 90 per cent.
Observers have been speculating that Finance Minister Jim Flaherty would take steps to tighten mortgage credit in the next federal budget. The timing of the move suggests concerns are growing in government circles about household debt and its impact on the economy.
CIBC chief economist Avery Shenfeld referred to the mortgage changes as part of a larger move by the government to “force Canadians on a debt diet” as household debt levels sit at record levels.
“Policy makers now have that credit buildup in their policy gun sights, and will use higher rates and regulatory changes to bring spending into better line with income, and cool mortgage demand,” Mr. Shenfeld wrote in an economic forecast on Monday.
“Canadians aren't on the verge of a U.S.-style default crisis – not at these interest rates, and not with debt having been granted to stronger hands than was the case before America's crisis, when subprime mortgages and credit cards were given out like candy,” he said.
But maintain this diet of borrowing for five more years and debt obesity would indeed weigh down the household sector's momentum. It's time to start the borrowing diet now, and that means policies aimed at slower debt-financed consumption growth and a cooler housing market.”
Bank of Montreal’s head of Canadian retail banking supported the government’s move, since the bank has been primarily recommending mortgages with a maximum 25-year amortization to build more equity and retire the loan faster, rather than paying more interest.
“The actions announced today by Minister Flaherty are prudent, measured, responsible and timely,” Frank Techar, president of personal and commercial banking at BMO, said in a statement issued by the bank. “For many months, BMO has been encouraging Canadians to lower their total cost of household debt by paying down short-term higher interest debt and considering the benefits of a mortgage with a 25-year maximum amortization to help them save interest costs and pay down their mortgage faster.”
It’s not the first time the Conservative government has tinkered with the mortgage market. In 2008, Mr. Flaherty announced Ottawa would no longer back 40-year amortizations, with a goal of cooling down a hot real estate market and preventing the emergence of a housing bubble in Canada. At that time, the government said it would also back only mortgages where the buyer has put down at least 5 per cent, effectively eliminating zero-down mortgages.
Last February the Finance Department lowered the maximum amount Canadians could withdraw in refinancing their mortgages to 90 per cent from 95 per cent of the value of their homes. Mr. Flaherty also introduced a measure requiring borrowers to qualify for a five-year fixed-rate mortgage, even if they sought a variable mortgage at a lower rate. Until that change, home buyers only had to qualify for the higher of either a three-year fixed-rate or variable-rate mortgage.
The Canadian Association of Mortgage Professionals spoke to the government frequently over the last three months, and was pleased that the changes didn’t include any modification to the minimum down payment required to buy a home. And while president Jim Murphy said that he generally approves of the changes to amortization lengths, he hopes the government shows the same willingness to change if the market cools further.
“We understand why he did what he did,” Mr. Murphy said. “But we hope when the time comes, he’ll revisit that decision. Real estate is very important to the economy, and it’s crucial that we find a balance because you don’t want to overreact to temporary market conditions.”
He said a better choice would have been to keep 35 year amortizations, but force all applicants to qualify with the assumption of a 25 year amortization.
CAAMP, 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.
There was a jump in the number of Canadians using their mortgages to free up cash, with 18 per cent taking out equity as the cited a need for “debt consolidation or repayment.” The average amount borrowed against home equity was $46,000. Given that there are 5.65 million mortgage holders in Canada, CAAMP estimated the borrowing at $41-billion, about the same as last year.
“It is estimated that 30 per cent of the takeout was for debt reconsolidation and repayment,” the report stated. “Therefore, while the amount of outstanding mortgage debt would have increased by this amount, totals for other types of debt would be correspondingly reduced. About $15-billion was taken out for renovations, $6-billion for education and other spending, $7.5-billion for investments and $4-billion for other purposes.”
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