Who will suffer in the end?

A cloud of uncertainty is hanging over the mortgage industry in Canada. High level tough talk from both the Minister of Finance Jim Flaherty and the top man at Bank of Canada, Mark Carney, about the household debt and the ever rising home prices has finally materialized into something. At this point it is just a draft, called with a code name B-20, but it is well on the way to become a law as early as this June.

The 2012 Federal Budget delivered the minor blow – announcing almost 20,000 government layoffs, most of them in the Ottawa-Gatineau region. The effect on housing is still to be measured and analyzed. The more significant blow was delivered just as a hint – promising stronger government control over the main mortgage insurer in Canada – the Canada Mortgage and Housing Corporation (CMHC). This “hint” unleashed a flurry of speculations some of which were ridiculous (“CMHC would stop insuring mortgages”), but now we know what the government had in mind – it has appointed the Office of the Superintendent of Financial Institutions Canada (OSFI) to oversee CMHC and to update the rules related to residential mortgages. The proposed changes were circulated among the affected industry players for comments in late April. If approved, the new rules would have long lasting negative effect.

Victim number 1

“Mr. Smith, unfortunately, we can’t renew your mortgage, because….” Getting a letter from you bank with such a frightening beginning, may become a reality for many borrowers in the future. The proposed rule calls for going through a full qualification process anytime one wants to renew a mortgage with the same lender. So far it was easy – at the end of your mortgage term the bank will send you a renewal letter with their offer, you sign on the dotted line and off you go for another 5 years. No verification of income or employment, no request for any additional documents. The idea was that if you have been paying the mortgage diligently for 5 years, you will continue to do so in the future.

Not any more – at a renewal time you will be treated the same way as a brand new applicant. Many things may have changed in your life within these 5 years, which may not fit with the new rules. What would you do if you can’t renew your mortgage? Sell the house?

Victim number 2

Home buyers still can’t understand why their 5-year mortgage rate is 3.49%, for example,  but they have to qualify based on a much higher rate of 5.44%. The answer is simple – because their down payment is less than 20% and the mortgage must be insured. For a couple of years now Bank of Canada publishes every week their five-year benchmark rate, which is to be used for qualifying insured mortgages.

Those who had larger savings and were able to put 20% down or more were qualified based on the actual mortgage rate (much lower than the benchmark rate) and thus they were able to either buy larger home or qualify for a mortgage with lower income.

Not any more – any buyer, regardless of the size of the down payment, would have to qualify based on the benchmark rate if they chose a term less than 5 years.

Victim number 3

Just when you were thinking to take a good chunk of money out of your equity in the house and use it as an investment for your retirement, your banker may say “Sorry, there is not enough equity”. The status quo was simple enough – if you have more than 20% equity, you can apply for a HELOC (home equity line of credit) and benefit from accessing these money at a very low interest rate. HELOC have been very popular for funding major projects like renovations, paying tuition fees, financing bigger purchases like a car, or a second property.

The proposed changes will cause home owners to wait much longer before being able to use a HELOC. The new requirement is to have at least 35% equity available to qualify for an equity line of credit.

Victim number 4

… is you again, if you are the one who still carry a mortgage and are approaching retirement. The government suggests lenders to consider the drop of income after retirement when approving mortgages for this group of borrowers. In another words, you may not qualify for a renewal of the mortgage if you are a year or two before retirement. Immigrants, who have come to this country in their 40s and after working hard for 10-15 years have finally managed to establish themselves, save money and plan to buy a home, may be out of luck. The lenders, following the government guidelines, would scrutinize the ability of any borrower to pay the mortgage after retirement. My suspicion is that many applications will be declined.

And this is not all

There are other little details that, if they remain in the final guidelines, would make the process of financing your home more difficult than ever. The worst case scenario is demand for housing to dry up, housing prices to fall and the economy to go back into a recession. I would not matter where the prime rate is – it may stay at the current level for another 5 years, if the rules are different the industry will suffer.