Feb 11, 2010 Tara Perkins and Boyd Erman Globe and Mail
Under pressure from major banks, Flaherty considers tougher regulations to govern how mortgage borrowers are evaluated
Ottawa is considering new rules that would force banks to use tougher criteria to evaluate mortgage borrowers, a move to ensure that consumers aren't taking on more debt than they can handle when they buy a home.
The key proposal under discussion would see the creation of new conditions the banks would have to follow when determining whether a customer can afford a mortgage, according to sources. Those rules would require banks to consider whether a person who takes out a variable-rate mortgage on a home can continue to make the payments if interest rates were to go up significantly.
Finance Minister Jim Flaherty is under pressure from a number of experts, including executives of major Canadian banks, to take action in the face of surprising strength in the country's housing market, which shows no signs of letting up. The fear is that many of the borrowers who are buying homes because of unusually low mortgage rates will struggle with their monthly payments when interest rates rise. That could have a dampening effect on the broader economy by prompting consumers to cut back their spending as they direct all their money toward their mortgages.
Senior bankers have privately urged government officials to increase the minimum down payment on homes from 5 per cent, or shorten the maximum time over which borrowers can spread out their payments, which is currently 35 years.
Mr. Flaherty and officials within the Finance Department and Canada Mortgage and Housing Corp. have been meeting with various players in the mortgage industry to consider options.
But Ottawa does not believe that there is a housing bubble at the moment and, having done some analysis to determine the impact that higher down payments and shorter amortizations would have, the Finance Minister believes that such moves would take too much heat out of the market and damage the economic recovery, according to sources.
Other options that have been suggested include measures that would apply only to people with bad credit scores, or to people who are buying investment properties that they don't intend to live in. But some banks argue that such rules would be difficult to enforce.
Instead, the idea now gaining traction is creating new rules that would govern how the banks evaluate mortgage borrowers. For example, Ottawa could say that – in order to qualify for federally backed mortgage insurance, which most new mortgages require – a borrower seeking a three-year variable-rate mortgage must be evaluated as if they are applying for a five-year fixed-rate mortgage.
If the three-year variable rate is 3 per cent and the five-year fixed rate is 5.5 per cent, such a rule would help ensure that the customer could lock in their rate and still afford their monthly payments when the Bank of Canada pulls the trigger on interest rate increases.
While some banks are already doing this behind the scenes, there is no standardization. Each bank has its own underwriting criteria and some are tougher than others. For instance, some banks ensure that their customers can afford their monthly mortgage payments if they were 100 basis points or 200 basis points higher. What Ottawa is considering doing is imposing standard minimum rules that banks would use to determine whether customers can service their mortgage debt. It's not clear how stringent the rules would be, or whether they would only apply to variable-rate mortgages. This would be a much easier move, politically, for Ottawa than increasing down payments – an idea prospective buyers are more likely to react negatively to.
Peter Aceto, the chief executive of ING Direct Canada, said that such a move would be a better solution than raising down payments or decreasing amortizations.
“This is a more surgical approach, as opposed to using a sledgehammer,” he said. “I think this is certainly a step in the right direction.”
ING has recently begun inserting a new line on customers' mortgage commitment letters that tells them not only what their monthly mortgage payments are, but also what they will be when interest rates rise.
In an interview on the Business News Network yesterday, former Bank of Canada governor David Dodge said that “CMHC should be very careful about the terms and conditions on which they're giving mortgage insurance.”
A lot of people are probably being induced into the mortgage market who won't be able to carry their mortgage debts over the long term, he suggested.