BILL CURRY, GRANT ROBERTSON AND TARA PERKINS
The Globe and Mail

The federal government is moving again to tighten the rules on mortgage lending in Canada amid growing concerns that the housing market is overheated and household debt levels are climbing to perilous levels.

The country’s biggest banks were caught off guard on Wednesday night as the Department of Finance prepared to clamp down on mortgages by reducing the maximum amortization for a government-insured mortgage to 25 years from 30.

Ottawa will also limit the amount of equity that can be borrowed against a home to 80 per cent of the property’s value, down from 85 per cent.

The moves are designed to cool the housing market and limit the record levels of personal debt Canadians have amassed in recent years. Figures from Statistics Canada show the average ratio of debt-to-disposable income climbed to 152 per cent, up from 150.6 per cent at the end of 2011. A rise in interest rates or further job losses could put some households at financial risk, endangering any economic recovery.

The Bank of Canada is expected to keep interest rates low for some time because the economy shows little sign of a strong recovery, so tightening mortgage rules is one way to ensure Canadians don’t get in over their heads during a prolonged period of ultra-low interest rates.

Reducing the maximum amortization on government-backed mortgages will eliminate the 30-year mortgage for most borrowers in Canada. The changes, which are expected to be unveiled at a news conference in Ottawa on Thursday morning, will translate into higher monthly payments, but result in the loan being paid off sooner.

Ottawa will announce two other changes, according to a source. It will no longer allow high-ratio mortgages over $1-million, and it will cap the gross debt service (which looks at a consumer’s total debt payments as a percentage of their income) at 39 per cent. While many banks tend not to allow mortgages over 40 per cent, there had been no official rule in place.

It is the fourth time in four years that Ottawa has moved to cool the housing market by tightening mortgage rules. In early 2011, Finance Minister Jim Flaherty reduced maximum insured amortizations to 30 years, and limited borrowing to 85 per cent of the property value.

CIBC economist Benjamin Tal described the changes as a “gentle push,” since the government didn’t make alterations to the minimum downpayment required on mortgages, which stands at 5 per cent.

“The fact that they didn’t change downpayments is a realization that doing so would probably be too severe given that the market is slowing down,” he said.

However, there remain concerns the changes could cause too abrupt a shift in the market. “All of these things might precipitate the housing market downturn that the government wants to avoid,” Jim Murphy, CEO of the Canadian Association of Accredited Mortgage Professionals, said in an interview.

Martin Pelletier
Financial Post

Bank of Canada governor Mark Carney has been warning consumers for some time not to get too comfortable, since higher interest rates are on the horizon. We think this is more of a scare tactic to get overleveraged consumers to rein in their borrowing levels, because Canada is certainly not on solid enough footing economically to raise interest rates, at least not until its trade partners do.

The problem is many Canadians aren’t listening, They’re partying like its 1999, taking on vast amounts of debt because of low interest rates and robust housing prices. While the level of household debt to GDP is falling in the U.S., it’s been increasing in Canada and now stands at more than 93%.

Consumers in the U.S. have been deleveraging since the 2007 collapse of their housing market. Perhaps this is because many don’t have a choice given the large drop in asset values, primarily housing. The Survey of Consumer Finances points out that U.S. households experienced a whopping 39% drop in their median net worth to US$77,300 in 2010 from US$126,400 in 2007, wiping out 18 years of gains in the process.

The U.S. Federal Reserve has responded by reducing interest rates to near zero and running the money printing presses 24-7. However, all this money supply has been sucked up with little impact on velocity — the rate at which money is used for purchasing goods and services — so there has been limited flow through to the consumer.

Since slightly more than one-third of U.S. house owners are underwater on their mortgages, consumers have had no choice but to deleverage. Total U.S. domestic debt as a share of the economy has declined for the past 12 consecutive quarters, MarketWatch reports, and the ratio of total debt to gross domestic product has fallen to 3.36 from 3.73.

As a result, U.S. household debt to GDP has significantly improved, falling to 84% from its peak of 98%. Some of the research we’ve seen shows that economic growth becomes impaired whenever this ratio surpasses 85%, so the U.S. is certainly cleaning up its act.

It’s a different story in Canada, though, and we think this is why Mr. Carney is concerned. We believe the catalyst for deleveraging to begin in Canada won’t likely come from a U.S.-style housing collapse given our country’s more prudent lending standards. That said, there are some markets such as Toronto and Vancouver that have seen a flood of direct foreign investment that, if curtailed, could result in a pricing pullback. Combine this with higher interest rates and there is likely going to be some trouble ahead.

We have expressed concerns in the past about how higher rates pose a risk that many bond investors have not considered. How many investors in 10-year Government of Canada bonds know that if interest rates were to double to 4%, the value of these bonds will fall by nearly 15%?

But there is another way to play this. The prudent investment for Canadians with a floating-rate mortgage is to take any extra savings and apply it to the principle.

For example, assuming one is paying the prime interest rate, which is currently 3%, a before-tax, risk-free investment would have to yield approximately 5% to offer the same return as paying down a mortgage.

By paying down their mortgages, investors will also be in a much better position to take advantage of the market when rates eventually revert to higher levels.

Overall, we don’t think this will happen for some time yet, perhaps another year or two at the earliest, so this is a trade that still has some legs to it.

By Les Whittington
Moneyville

OTTAWA—Despite repeated Bank of Canada warnings of higher interest rates to come, Canadians are unlikely to see an uptick in borrowing costs for many months as the world business climate weakens.

With Europe in financial turmoil, central bank governor Mark Carney is almost certain Tuesday to keep the bank’s trend-setting overnight rate at 1 per cent.

But the rate-setting announcement will be closely watched to see how Carney handles the balancing act created by the need to keep inflation in check without allowing Canada to be dragged down by weakening economic conditions abroad.

In his last rate decision in April, Carney caused a stir in financial circles by hinting that it “may become appropriate” before long to push up interest rates—a warning that reflected concerns about inflation and risky levels of Canadian household debt fed by historically low borrowing costs.

But the ground has been shifting under Carney’s feet in recent weeks. The recovery in the United States remains tentative, growth is slowing in emerging market giants China, India and Brazil and Europe is once again teetering on the edge of a financial meltdown that would damage economies everywhere.

Also, Canada’s economy grew by only 1.9 per cent on an annualized basis in the first three months of this year, well below Carney’s estimate of 2.4 per cent in 2012.

Overall, the deterioration of the outlook is so sharp it has prompted speculation that the Bank of Canada might do an about-face and cut interest rates later this year.

But, with borrowing costs already near historic lows, economists say such a move seems unlikely barring a steep economic downturn.

“I don’t think the Bank of Canada has gone as far as the market, which is actually pricing in some odds of a rate cut down the road,” said CIBC World Markets chief economist Avery Shenfeld.

He said Tuesday’s statement “will have to recognize some of the deterioration outside of Canada” but Carney may repeat language used in previous announcements to keep Canadians aware of his intention to raise rates as soon as possible.

“There may be some wording that reminds markets that, whenever it comes, the next move is probably still a rate hike,” Shenfeld commented.

While most economists say an uptick in the central bank’s key rate is out of the question this year, TD Bank says Carney could still defy expectations and start ratcheting up borrowing costs this fall.

“If we think about domestic conditions, interest rates are already at incredibly low levels and we’re having at least close-to-trend economic growth,” TD economist Diana Petramala said. “And household credit has bounced back in recent months. So, domestic conditions may warrant even higher interest rates.” However, she said this forecast hinges on the avoidance of a deeper financial crisis in Europe.

If Carney has to back away Tuesday from his April 17 warning that higher rates are coming, it will be the second time in a year he has been forced to do so. Last July, he issued a similar warning. But that intention was derailed by the financial upheaval in Europe in late 2011.

The central bank has kept its trend-setting rate at 1 per cent since September 2010 to try to shore up the economic recovery in Canada.

The Canadian Press Jun 14, 2012
Financial Post

OTTAWA — Canada Mortgage and Housing Corp. raised its expectations for housing starts this year on Thursday, but said it expects both new and existing home markets to moderate in coming months after getting off to a strong start early in the year.

The agency’s second-quarter housing market outlook said housing starts will be in the range of 182,300 to 220,600 units this year, up from a forecast in February for 164,000 to 212,700 starts in 2012.

CMHC deputy chief economist Mathieu Laberge said condo construction helped drive housing starts in the early part of the year, but noted it varies significantly from month to month.

“Although economic conditions are expected to remain supportive of housing demand, housing starts activity is expected to moderate as 2012 progresses,” Laberge said in a statement.

“Similarly, balanced market conditions in the existing home market will result in modest house price gains through to the end of the year.”

It forecasts that the number of existing home sales will be in the range of 431,200 to 516,100 units this year and the 2013 range will be about the same at between 431,300 and 522,400 units.

The outlook suggests the average Multiple Listing Service price will range between $341,100 and $406,700 this year and between $346,000 and $419,900 next year.

It said the moderate increases in the average price, of two to three per cent, are consistent with the balanced market conditions that are expected to continue in 2012 and 2013.

The report came as Statistics Canada said its new housing price index rose 0.2% in April, following a 0.3% increase in March. On a year-over-year basis, the index was up 2.5% in April, following a 2.6% in March.

The agency said the metropolitan regions of Toronto, Oshawa, Ont., and Edmonton were the main contributors to the March to April increase.

St. John’s, N.L., St. Catharines—Niagara and Windsor, Ont. all reported price declines of about 0.1%.

Continued strength in the housing market, largely due to the staying power of low interest rates, has led some economists to warn the market is overvalued.

They have warned that could make homeowners vulnerable to a downturn, especially those who have used low interest rates to borrow more than they could otherwise afford.

The Bank of Canada and federal Finance Minister Jim Flaherty have warned Canadians repeatedly to moderate borrowing on real estate, declaring household debt to be the domestic economy’s number one enemy.

The Canadian Press

Sunny Freeman, The Canadian Press
Financial Post

TORONTO — Canadian housing market conditions have cooled slightly, with prices down nearly 2% in the first-quarter, but the country continues to outperform other developed nations, according to a new Scotiabank real estate report.

The latest Scotiabank Global Real Estate Trends report released Wednesday found that the inflation-adjusted national average home price fell by 1.6% in the first quarter of 2012 compared to the same period of 2011.

That compared with a 1.3 inflation-adjusted year-over-year gain in the fourth quarter of 2011.

Canada’s housing market remains an outperformer among developed nations, but conditions have cooled here as well, according to Scotiabank economist Adrienne Warren.

“Price trends are relatively steady in the majority of local markets, though a few, notably Toronto, continue to report strong appreciation,” Warren writes in the report, released Wednesday.

Demand has cooled due to moderate income growth and tighter mortgage insurance rules. In addition, there are more houses up for sale in most parts of the country.

Scotiabank said it expects the number of sales and average prices will be flat in the latter half of 2012.

By comparison, it found global property markets remain under stress, especially in recession-plagued European countries. Ireland saw prices fall a whopping 18.9% and prices in Spain, which has experienced a housing crash, fell 9.1% year-over-year.

Over the weekend, eurozone finance ministers offered to make $100 billion available to Spain to revive banks crushed by bad real estate loans. However, market reaction suggests many observers didn’t feel the relief was enough.

Most countries covered by the Scotiabank report saw prices decline during the quarter.

“The intensifying eurozone debt crisis, increasing financial market strains and moderating global growth suggests there is more downside risk to property prices in the near-term,” Warren said.

“Eventually, however, improved housing affordability and pent-up demand will put many of these markets on a firmer footing.”

Scotiabank projects that the era of ultra-low borrowing costs will continue in most developed economies, while many developing economies are moving to reverse prior hikes.

The latest figures on Canada’s housing market from the Canadian Real Estate Association are due Friday, measuring the strength of sales and prices in May.

In April, the average home price in Canada was up 0.9% from a year ago at $375,810, while sales on a year-over-year basis were 49,480, up 11.5% from 44,370 a year ago, CREA said.

Continued strength in the housing market, largely due to the staying power of low interest rates, has led some economists to warn the market is overvalued. That could make homeowners vulnerable to a downturn, especially those who have used low interest rates to borrow more than they could otherwise afford.

A report released earlier this week by the Toronto-Dominion banking group projected Vancouver and Toronto home prices will probably experience a downturn of about 15% in two to three years, but not the dramatic drop that hit the United States a few years ago.

The Bank of Canada and federal Finance Minister Jim Flaherty recently stepped up their warnings to Canadians to moderate borrowing on real estate, declaring household debt to be the domestic economy’s number one enemy.

By David Aston | From MoneySense Magazine

The great financial quandary for many Canadians in their 20s and 30s is how to save for retirement and also buy their first home. The classic advice—made famous by David Chilton in The Wealthy Barber—is you should put away at least 10% of your pre-tax income for retirement, even when you’re trying to save for a down payment or pay your mortgage. But can you do both at the same time with today’s lofty housing prices?

In most cases, you no longer can. Since the first edition of Chilton’s book appeared in 1989, the wages of typical Canadian workers (barbers or otherwise) have not kept up with the rising cost of houses, especially in larger cities. In my view, the slow and steady 10% savings rule just isn’t realistic for most young homeowners these days. So what should you do instead?

Consider an alternative strategy devised by Malcolm Hamilton, partner at Mercer, a human resources consultancy. You might call it the 20% strategy. He suggests earmarking 20% of your income for either housing payments or retirement savings throughout your life: “The entire 20% goes to the mortgage until the mortgage is gone, then the whole 20% goes to the RRSP,” says Hamilton.

I agree this strategy should help a lot of young Canadians afford a home and save for retirement. But Hamilton and Chilton agree it’s not for everyone. Will it work for you?

Different ways to build wealth. The beauty of the 20% strategy is that it allows you to successfully achieve two of life’s biggest financial goals. Early in life you can focus on buying as nice a house as you can afford, and you’ll pay off the mortgage as quickly as possible as your salary grows. Next you save for retirement in an intense, concentrated period. In my experience, this approach fits well with how most people naturally set their priorities.

Saving for retirement just isn’t important to most Canadians in their 20s and 30s, who are often desperately eager to buy a comfortable home in a good neighbourhood. But after buying that home, they chafe under the mortgage and want to get it off their backs as soon as possible. Then finally they turn their focus to building their retirement nest egg at a stage of life when that becomes increasingly important. It can all work out perfectly well, since paying off your mortgage and building up your investment balance are just different ways to build wealth.

To show how the 20% strategy could work in practice, I have developed a fictional scenario for a typical middle-class Canadian couple we’ll call Eric and Jennifer. Starting in their mid-20s, Eric and Jennifer set aside 20% of their income in order to accumulate a down payment on a home. Then in their early 30s they’re able to buy a $325,000 house with a mortgage of $260,000 (in today’s dollars). Each year they increase their mortgage payments in proportion to their growing salaries in order to pay it off in 17 years, just before they turn 50.

With the mortgage gone, they turn to building up their nest egg by applying 20% of their income (plus RRSP tax rebates) to savings. That allows them to save $525,000 (again, in today’s dollars) by the end of the year they turn 65. That’s more than adequate to provide a comfortable retirement.

Customize the strategy. Adopting this mortgage and savings plan at the 20% level should suit Canadians in average circumstances, says Hamilton. But to sustain their lifestyle in retirement, affluent Canadians should save more, while low-income Canadians will need less, he says.

Other circumstances may force you to tweak the strategy. Many young people are hobbled with enormous student debt and can’t start saving for a down payment immediately after graduating, although a good education might help earn bigger salaries later on. The plan also assumes you will have virtually no savings until you’re in your late 40s or early 50s, which isn’t the case for many people. Few Canadians outside the public sector enjoy good defined benefit pensions anymore, but many will by then have significant amounts in more modest employer-sponsored plans, or RRSPs and TFSAs. For better or worse, you’ll probably need to adjust the numbers accordingly.

Do you have the discipline? While Hamilton’s strategy should ease the path to home ownership and retirement savings for many Canadians, that doesn’t mean it’s easy. Like the slow and steady 10% savings approach, it too requires discipline. To do it properly, you first need to increase your mortgage payments as your salary increases in order to pay off the mortgage quickly. As a rule of thumb, if you have no other substantial savings or pension, you need to pay off your mortgage 15 to 20 years ahead of your retirement date, says Hamilton.

Then when you’re mortgage-free, you need to have the discipline to change gears: after decades of putting it off, you will need to suddenly embrace investing. That means socking away the full 20%, and avoiding the temptation to buy a larger house with a new mortgage, or ramp up your lifestyle expenses. (In my view, most people should also save their RRSP tax rebates on top of the 20% to make the most of the strategy.)

This is harder than it may sound. Chilton talks to a lot of people about their finances, and he says that while many Canadians are good at paying off their mortgages, he finds a large proportion don’t subsequently save enough when the mortgage is gone. After all, unless you’re willing to let the bank foreclose, you don’t have any choice when it comes to your mortgage payments. But you can come up with a dozen reasons not to invest regularly.

“I have no issue with people doing Malcolm’s approach as long as they avoid the behavioural issues,” says Chilton. Hamilton himself agrees that if you think you may lack the discipline to save large amounts late in your career, you’re probably better off sticking with the traditional approach.

Slow and steady wins some races. Indeed, while the 20% mortgage and savings rule should work well in many cases, it’s not for everybody. If you can start early and save a steady 10% of your income without jeopardizing your dreams of home ownership, then do it. The 10% rule recommended by Chilton is a proven strategy. Consider the fictional example of Hannah, a single woman who earns $50,000 a year (in today’s dollars) throughout her career. By saving 10% plus RRSP tax rebates over 40 years, she’d accumulate $450,000 nest egg in today’s dollars (assuming a conservative 5% return with inflation of 2.5%). That should provide her with a comfortable retirement if she also owns her home mortgage-free.

But the slow and steady strategy has potential pitfalls of its own. In particular, you’ll need to save more if you start late. “If you start at 46—or even 35—you have to save more than 10%,” says Chilton. “This is something we haven’t driven home as well as we should.”

Consider the example of Sergei, who has the same income as Hannah, but only starts saving at around age 40, leaving him just 25 years before retirement. Sergei has to save about 20% of his income to accumulate about the same nest egg as Hannah did by saving 10% for a longer period. In addition, if you’re a renter, you should probably save more than 10% to compensate for the fact that a paid-for home is a valuable asset that reduces your accommodation costs in retirement compared to equivalent rental properties.

Plan for the unexpected. No matter how good your plan, you never know how things will work out. With luck, the pleasant surprises (bigger salary increases, better investment returns, an unexpected inheritance) will at least offset the bad (maybe rising mortgage rates or falling housing prices after you purchase, or personal misfortune such as divorce, business failure or job loss). As Hamilton says, all you can do is “steer up the middle” and adjust when necessary.

That’s easy if the good surprises exceed the bad. But what if events turn out unfavourably? One thing to realize is that saving 20% of your income after your mortgage is paid off often leaves room to save more if you need to catch up. My sense is that saving 20% represents a moderate level of frugality for Canadians who are mortgage-free (see “How much can you save?”) If need be, you can probably save about 25% of your income, or more if you set your mind to it, especially late in your working life if you have no children, or if your kids are financially self-sufficient. And that’s not counting RRSP tax rebates. If you save those as well, that could bring your overall savings rate to 30% or more. So even if things don’t work out as you hoped, there’s a lot you can do to catch up.

While Chilton and Hamilton recommend different saving strategies, they hold each other in great regard. They also wholeheartedly agree that the best general advice you can follow is live within your means, pay down your mortgage and other debt as quickly as you can, and steadily build up your savings for retirement as soon as you can manage it. Do that diligently and you should enjoy a comfortable retirement—whatever strategy you use.

By Susan Pigg
Moneyville

Canadians are “well positioned” to weather a rise in interest rates and are heeding the warnings from Ottawa about the risks of being house poor, according to a new study that provides a fascinating glimpse of mortgage indebtedness.

Some 83 per cent of Canadians have at least 25 per cent equity in their homes and homeowners are making significant efforts to get out of debt early with 23 per cent increasing their monthly payments, 19 per cent making lump-sum payments and 10 per cent doing both.

The average increase in payments is $400 to $450 per month, resulting in a combined $7 billion worth of voluntary extra payments per year among Canada’s 5.85 million mortgage holders, according to a survey by the Canadian Association of Accredited Mortgage Professionals (CAAMP), the national association for some 12,500 mortgage brokers.

Lump sum payments averaged $12,500, amounting to a combined $13.75 billion worth of fast-tracking mortgages, says the report released Wednesday.

Despite wildly escalating house prices, especially in major centres like Vancouver, Toronto and Calgary, the average outstanding principal is just $170,000, according to the report authored by economist Will Dunning.

There are currently about 9.85 million homeowners in Canada and just under 6 million of them have mortgages. While 3.75 million may be mortgage-free, they may have other debt not reflected by the study.

Perhaps not surprisingly, most of those surveyed feel comfortable with their own level of debt — but they worry about others.

“There’s a bit of a disconnect there,” acknowledges Jim Murphy, president and CEO of CAAMP. “But the research tells us that people can handle it (their mortgage debt.) There is a small minority — maybe one or two per cent — who would have trouble if interest rates start to rise.”

Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney have been unrelenting the last few months in their warnings about the historically high levels of household debt and have made significant moves to rein in the ability of Canadians to borrow with abandon.

Banks have been warned to be responsible in their lending and home equity line of credits have also come under the microscope as Canada’s housing boom has helped turn homes into virtual ATMs to finance home renovations, investments and indulgences like travel.

Canadians currently have $994 billion in outstanding mortgages on primary residences. They owe some $161 billion in Home Equity Lines of Credit (HELOCs.)

Just in the last year Canadian homeowners have taken out $46 billion in HELOCs, with $17.25 billion used to finance renovations, $10 billion to fund investments and $9.25 billion for debt consolidation, says the survey, Confidence in the Canadian Mortgage Market.

The report notes that Canadians with HELOCs have an average of 82 per cent equity in their homes while those with a combination of mortgages and HELOCs have an average of 41 per cent equity in their homes.

“Generally the numbers are very good. We’re not the United States. We’re not Spain,” says Murphy. “But we need to be mindful that we’re not always going to be in a low interest rate environment and that it’s always good to pay down your mortgage and live within your means.”

For the first time, the annual spring survey also took a look at the rental market, asking why more renters aren’t buying: 52 per cent cited the inability to cobble together a down payment.

And it issued a subtle warning to Ottawa, which has already tightened up bank mortgage and amortization rules and fears persist that there is more to come, including an increase in minimum down payments.

“Data gathered in this study suggests that if the minimum down payment in Canada was 10 per cent rather than the current 5 per cent, during 2007 to the present, home purchases might have been 100,000 units per year less than they were,” the survey says.

The fallout could have hurt the construction industry, house prices — which may have fallen — reduced consumer confidence and created a tighter rental market with increase rents.

“It is essential for the health of the housing market, and therefore for the broader Canadian economy, to maintain access to high-ratio mortgage funding,” it notes.