After analysing the newest mortgage changes announced by Jim Flaherty, it is pretty difficult to find fault with the government's decision to tighten up on residential mortgage borrowing. Believe me, I tried my best to poke holes in last weeks announcements.
The government has taken major steps to cool down the Canadian Real estate market as soon as possible. Flaherty has taken four steps:
Reducing the amortization period for mortgages to 25 years from 30 years
Lowering the amount that Canadians can borrow against their homes to 80 per cent from 85 per cent
Constraining maximum gross debt service ratios to 39 per cent and maximum total debt service ratios to 44 per cent
Limiting government-backed mortgage insurance to houses under the $1 million threshold.
The new rules, effective July 9, 2012, give Canadians 5 fewer years to pay off their loans and also minimize the impact of high-ratio mortgages. In laymen's terms, these are mortgages with small down payments, typically less than 25% of the purchase price. First-time and young buyers are likely to be the most affected, as mortgage borrowers will now be required to make higher monthly payments on their mortgages. But wait. The higher monthly payments are not as scary as they sound. Looking at a $200,000 property with a 5% fixed interest rate, the difference between a 35 year amortization and a 30 year amortization is an extra $64.54. In other words, if you can already afford $1,002.85 a month, you can probably afford $1,067.39 a month. If you have to wait one more year to get that raise at work, which will allow you to purchase a home, there's still 5-years less of your life devoted to paying off that mortgage. That's what these new rules do for you: they get you out of debt faster.
These rules may seem unfair for the few who can't make the difference in monthly payments but there's a much larger picture: the Canadian economy. It's important to remember that the huge housing crash in the United States was largely caused by banks giving mortgages and loans to people who couldn't actually afford to pay them back. In comparison, Canada was less generous with loans and was not hit as hard. This new government initiative will help keep it that way.
Despite the short-term pain, it is clear that housing volatility will be reduced by these moves. And that is a positive for all Candians.