Royal LePage Realty Plus Oakville

New Mortgage Rules Coming Next Week…

In recent years, there have been many changes to the mortgage rules. Finance Minister Jim Flaherty has implemented the various changes to prevent a housing bubble (which is just fancy-speak for unsustainable growth and a subsequent crash). The first changes came in 2008, when the federal government limited the maximum amortization period for mortgages to 35 years and mandated a minimum down payment of five percent. A few years later, the rules were further tightened, reducing the maximum amortization period from 35 to 30 years, reducing the maximum amount that Canadians may borrow against their home equity from 90 percent to 85 percent, and terminating government insurance support on home equity lines of credit. And recently, Jim Flaherty announced another tightening of mortgage rules, which will take effect on July 9, 2012. First, the maximum amortization period for mortgages was again reduced – this time, from 30 years to 25 years. Second, the maximum amount that Canadians may borrow against their home equity was similarly reduced again, from 85 percent to 80 percent of the property’s value. Third, high-ratio mortgage insurance will no longer be available for properties valued at over $1 million. Fourth, new rules tighten how mortgage brokers calculate the amount that they are willing to lend, based on your debt and income ratios.

But how will these new changes affect the average buyer? For starters, none of the rules will impact existing mortgages, as the changes are not retroactive. The change that will affect the most people is the reduction in the maximum amortization period. While it ultimately leaves a borrower with more money in her pocket, it also means a higher monthly mortgage payment. Consider a practical example. With a 30-year amortization period, a $400,000 mortgage with an interest rate of five percent would require the borrower to make monthly payments in the amount of $2,134.76. With a 25-year amortization period, the same $400,000 mortgage with an interest rate of five percent would require the borrower to make monthly payments in the amount of $2,326.42. In other words, the new rules require the borrower to come up with an extra $191.66 every month. But what about the savings? People often underestimate the cost of mortgages. In the above-described example, the five-year difference in amortization period saves the borrower a whopping $71,516.26 over the life of the mortgage! That is no small amount of pocket change! So, you trade a higher monthly payment for a greater overall savings. But aside from the higher monthly payment, will it affect the size of mortgage for which a borrower may qualify? In short, the answer is, “Yes.” If a borrower needs a $500,000 mortgage to purchase a given property, but her income doesn’t afford her the monthly amount she needs for a lender to grant a mortgage of that value, she no longer has the option of reducing the monthly payment and extending the amortization term. She must instead spend less on a property and borrow a smaller amount. Given that Canadians’ debt-to-income ratio recently hit a record high, conservative changes designed to protect borrowers from over-borrowing may not be as paternalistic as they seem.

While the second and fourth change require little comment, the third change is worthy of some consideration. Savvy buyers know that if at all possible, one should have a twenty percent down payment. While it is possible to have a smaller down payment, that smaller down payment comes at a price – one must then purchase high-ratio mortgage insurance if one’s down payment is between five and nineteen percent (with down payments of less than five percent not permitted, even with insurance). The new rules take away the option of a smaller down payment for properties valued at over $1 million. Presumably, the reasoning is that the more expensive properties are subject to greater value fluctuations when markets soften. And because markets are indeed expected to soften in the near future, this new measure simply softens the blow of the softening, if you will.

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