Mortgage changes will affect soft markets, analysts say

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Ottawa's changes to mortgage insurance rules will reverberate far beyond the overheated markets of Toronto and Vancouver, with analysts expecting the stricter requirements to have even greater impacts in parts of the housing market that are already soft.

Financial experts say the changes, including new qualifying standards for five-year mortgages, could slow sales in Atlantic Canada, Alberta and Quebec, where the markets do not need cooling off, and in cities and suburbs where buyers are seeking refuge from out-of-control prices. And the new rules are expected to have no effect on the most controversial segment of the market – the single-family detached houses in Vancouver and Toronto that are selling for more than $1-million.

"Traditionally, the five-year term specifically has been the bread and butter of the market," said Royal Bank of Canada senior economist Robert Hogue. "My sense is that this particular announcement will have an effect, potentially quite material, across the board, not just in Toronto and Vancouver."

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Federal Finance Minister Bill Morneau introduced the changes this week, which he said were sparked by concerns over rising household debt levels in Canada. For home buyers, the biggest change involves tougher "stress-testing" requirements for insured mortgages.

Starting Oct. 17, all home buyers with down payments of less than 20 per cent must prove they can afford payments for a mortgage based on the Bank of Canada's posted five-year fixed mortgage rate, currently 4.64 per cent. The posted rate is the most common five-year rate advertised by the Canadian banks, although actual rates are frequently lower. Under existing rules, borrowers who take out fixed-rate mortgages of five years or longer have their incomes stress-tested at the rate they will actually pay, which can be as much as two percentage points below the central bank's posted rate. Those who take out mortgages with shorter terms or variable interest rates must already qualify at the higher Bank of Canada rate.

Unlike the Liberal government's increases to down payment rules last year, which were aimed almost entirely at Toronto and Vancouver, the changes unveiled this week will affect a wide swath of new mortgages. Canada Mortgage and Housing Corp. reported that 93 per cent of mortgages it insured in the second quarter of this year were fixed rate. Many of those are thought to be five-year terms, which are popular because they allow borrowers to qualify for slightly larger mortgages.

Genworth MI Canada Inc., the country's largest private sector mortgage insurer, estimates that as many as a third of the home buyers it insures would not qualify under the stricter new rules.

Many of those are in the Toronto and Vancouver regions, where first-time buyers have been stretched the most financially to get into the housing market. But the rule changes will be felt in other parts of the country as well, said Genworth chief executive officer Stuart Levings.

"The unintended consequences might be that now they're putting pressure on buyers in Atlantic Canada, Quebec, Alberta, who might no longer be able to afford a house either, or have to downsize because of the same rule change," he said. "And those are not overheated markets that required any cooling at the moment."

Ironically, one segment of the market that is unlikely to be hit hard by the new rules is sales of detached houses in Toronto and Vancouver, said CIBC World Markets deputy chief economist Benjamin Tal. Those prices have gone so high that many are no longer eligible for mortgage insurance, which is restricted to less than $1-million. Mr. Tal expects that in those cities, the stricter mortgage qualification rules will have a larger impact on the market for condos, which are more popular among first-time buyers than single-family homes.

The communities around Toronto and Vancouver will also likely feel the effects of the rule changes, given that many buyers have flocked to places like Hamilton and B.C.'s Fraser Valley in search of more affordable home ownership, said BMO Nesbitt Burns senior economist Sal Guatieri. "That's where house prices have gone up significantly in the past year, much faster than incomes have gone up," he said. "So that's where I think we could see a more significant pullback in housing demand over the next year."

The Toronto Real Estate Board said it "will be closely monitoring" the changes to mortgage-lending standards, along with Ottawa's pledge to close loopholes in real estate tax laws. The federal government has said it will now require homeowners to report the sale of a primary residence on their income tax filings to avoid paying capital gains taxes on the sale.

However, the real estate board mainly blamed a shortage of supply for soaring home prices in the Greater Toronto Area. "While these changes are pointed at the demand for ownership housing, it is important to note that much of the upward pressure on home prices in the GTA has been based on the declining inventory of homes available for sale," wrote Jason Mercer, director of market analysis.

As many as 10 per cent of prospective home buyers might not qualify under the new mortgage rules, estimates Toronto-Dominion Bank economist Diana Petramala.

Along with new stress-testing measures for insured mortgages, Ottawa also unveiled stricter requirements for lenders who use portfolio insurance, or insurance for mortgages that have down payments above 20 per cent. Combined, the two changes will make it more expensive for lenders to finance their mortgage business, with banks likely to pass those higher costs on to consumers with higher mortgage rates, Ms. Petramala said.

The changes could help cool national home sales next year, with prices also likely to be affected negatively. "It's not enough to really derail the housing market," she said. "But it could take some steam out of housing at least in the near term."