Mortgage rules: A macro perspective – Everybody’s Business

Here’s my column on the new federal mortgage rule changes

 

One of the main responsibilities of the Bank of Canada is to ensure a low and stable rate of inflation. This objective has been put to the test by the federal government’s economic stimulus program and strong consumer spending, largely financed by household debt. The rising value of real estate has created a “wealth effect”, inciting consumers, who feel richer than they are, to take on debt to buy the goods and services they want.

With debt now representing 148 per cent of personal disposable income, Bank of Canada governor Mark Carney and federal Finance Minister Jim Flaherty are worried that deterioration of household balance sheets poses a risk to the broader Canadian economy.

Equally, there are concerns that the “wealth effect” will lead to inflation expectations, which could become a self-fulfilling prophesy.

Against this backdrop, Flaherty has tweaked the mortgage rules ostensibly to prevent a housing bubble and slow the increase in household debt. The changes announced Monday include lowering the maximum amortization period to 30 years from 35 years for mortgages insured by Canada Mortgage and Housing Corp., reducing the maximum amount of borrowing for refinancing a mortgage to 85 per cent of the value of a property from 90 per cent, and withdrawing government-backed insurance on home equity lines of credit.

But there’s another reason for the changes. From a macroeconomic point of view, the mortgage amendments give the central bank some breathing room. The central bank was inclined to raise interest rates to curb excessive borrowing and keep inflation within its target range.

However, higher interest rates could be an even greater threat to the recovery than household debt.

For a start, they would discourage business investment, which is key to a sustained recovery. They would also drive up the Canadian dollar, which reached parity with the U.S. dollar last week, with many analysts predicting a strong dollar throughout 2011.

Canada’s exports become more expensive when the value of the Canadian dollar soars, making them less competitive in global markets. Since exports still account for more than 30 per cent of gross domestic product, and 73 per cent are destined for the United States, a Canadian dollar at parity with the U.S. dollar, or above, could hamper economic growth.

If Flaherty can dampen the demand for debt without resorting to monetary policy tools, he’ll be able to sustain the economic lift provided by low interest rates while tapping the brakes on the borrowing binge and minimizing the risk of inflation.

Some analysts anticipate a slowdown in consumer spending this year in any case as the pace of job creation is expected to lag that of 2010. Moreover, CIBC World Markets sees a softening in the housing market in the second half. Given that the increase in household net worth this year will probably not match the eight-percent gain in 2010, consumer spending, being closely tied to net worth, will be subdued.

Although the federal moves have been described as prudent, sensible and even wise, home buyers may be in for a shock. Shortening the amortization period to 30 years from 35 years on a $300,000 mortgage at four per cent would increase the monthly payments by $104. The mortgage rule changes affect mainly high-ratio mortgages that require CMHC insurance, those with down payments of between five and 20 per cent.

Buyers who have the wherewithal to put down 20 per cent of the purchase price or more can still write their own ticket on amortization and many other mortgage terms.

If the new mortgage rules help revive the notion that people should save in order to buy a house, that would be a most significant achievement.

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About Tariq Sultan
Dear Readers, I am a dedicated Toronto, Ontario based real estate professional who has been successfully meeting and exceeding the needs of his clients for past several years. I am actively involved in the insurance, financing, and mortgage industry. Real estate is not only my career – it is my passion. I strive to continuously provide my clients with exceptional service to ensure they are fully satisfied when it comes to their real estate needs. For any real estate related inquires contact me today, I will be happy to assist you. Best wishes, Tariq Sultan

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