New Mortgage Rules: The Good, The Bad, The Ugly

On April 19 our government will lay down three major rule changes to “prevent” a housing-price bubble and keep homeowners from getting “overextended.”

Here is the official announcement from today:  Finance Department release

These new rules apply to government-backed insured mortgages only.

The Good:  5-Year Fixed Qualification Rates

• The New Rule:  Borrowers will need to qualify using a 5-year fixed rate regardless of what term they choose.  If you want a 1.95% variable rate, for example, you will need to show that you can afford payments at a higher fixed rate, like 4.09%.
• The Government’s Reasoning:  “This initiative will help Canadians prepare for higher interest rates in the future.”
• The Effect: It will now be harder to qualify for a variable-rate mortgage, but not much harder. Most lenders already use three- or five-year mortgage rates to calculate a borrower’s debt service ratios.  For many discount lenders, this means the qualifying rate will go from something like 3.25% to 3.89%—not a huge difference.
• The Verdict: A sound and necessary change--although many lenders already use similar guidelines.

The Bad:  90% Maximum Refinancing

• The New Rule:  No longer will you be able to refinance your home to 95% of it’s value. 90% will be the new refinance maximum.
• The Government’s Reasoning:  “This will help ensure home ownership is a more effective way to save.”
• The Effect:  Borrowers will be less able to pay off high-interest debt with lower-cost mortgage money.  On the upside, this rule has the positive effect of keeping equity in the home (which is quite helpful when home prices fall). It also discourages homeowners from relying on home equity to bail themselves out when they accumulate debt.
• The Verdict:  Bad…for people who need to restructure debt in an effort to pay more principal and less interest.  On the other hand, a 90% refinance limit is beneficial in that it deters people from racking up debt and using their homes as a proverbial ATM machine.

The Ugly:  80% Maximum Insured Financing On Rentals

• The New Rule:  People buying non-owner occupied rental properties will need to put down 20% to get an insured mortgage, versus 5% previously.
• The Government’s Reasoning: To reduce speculation.
• The Effect:  The number of investors creating rental housing will drop notably. Investors will need to borrow down payment funds elsewhere (assuming it’s allowed) or use higher-cost non-insured lenders (like TDFS) to get 90% financing. Note: This rule does not apply to multi-unit owner-occupied homes with rental units (like duplexes and triplexes).
• The Verdict:  Ugly.  How the government can go from 100% rental financing (17 months ago) to 80% today is confounding. The intent is understandable, but the government could have increased net worth requirements, increased Beacon minimums, tightened debt servicing guidelines, or limited the number of insured rental mortgages a person can qualify for. Instead, the solution was near-draconian, and it will have an effect on the rental stock in Canada. Will it cause a material rise in rents?  That’s a tough call, but it will definitely reduce the supply of rental units and limit Canadians’ investment options.

What to Expect:

• Undoubtedly there will be a rush of applications to beat the April 19 deadline. 
• The government says “Exceptions would be allowed after April 19 where they are needed to satisfy a binding purchase and sale, financing, or refinancing agreement entered into before April 19, 2010.”
• The 80% rental rule will crush the income property financing business for some lenders and brokers.
• If history is a guide, certain lenders will implement these guidelines early (i.e.  before April 19).

Interestingly, Minister Flaherty took a small jab at lenders in his release today, saying these rule changes are designed to “help prevent some lenders” from “facilitating” irresponsible lending. 

"If some lenders aren't willing to act themselves, we will act,” said Flaherty.  That’s bold talk given that Canadian lenders have exceptionally low default rates, and already conform their mortgages to all existing government guidelines.