Bill Curry and Grant Robertson, The Globe and Mail | January 17, 2011

Concern over rising consumer debt levels is prompting Ottawa to make three new changes to Canada's mortgage rules.

Finance Minister Jim Flaherty announced Monday that new federal rules will reduce the maximum amortization period to 30 years from 35 years for government-backed insured mortgages with loan-to-value ratios of more than 80 percent.

Secondly, Ottawa will lower the maximum amount Canadians can borrow in refinancing their mortgages to 85 percent from 90 percent of the value of their homes.

Thirdly, Ottawa will withdraw government insurance backing on lines of credit secured by homes.

Though longer amortization periods reduce monthly payments, they greatly increase the amount of interest paid over the life of the mortgage and make it harder to build up equity.

The average Canadian resale home sold for $344,551 in December. Assuming a five-year mortgage at 4 percent interest, and the minimum 5 percent down payment of $17,227, a 35-year mortgage would have monthly payments of $1,441. Shorten the amortization period to 30 years, and the monthly payment increases to $1,555.

At a news conference in Ottawa, Flaherty said the measures will encourage Canadians to save []more through home ownership. He said they will also reduce the exposure of Canadians to financial risks. Flaherty said his concern is not Canada's mortgage default rate - which is less than 1 percent. Rather his concern is those who are borrowing as much as possible.  "We're seeing people borrow to the max, and borrowing to the max at low interest rates," he said. "Most Canadians are not doing that."

Flaherty predicted the measures will have "some moderating" impact on the housing market.  He said the changes will not take effect imediately because of a requirement to give the industry 60 days notice before making policy changes of this nature.  He said past experience suggests there is no need to fear a rush on 35-year mortgages before the new rules take effect.

In addition to cutting mortgage terms, Ottawa is taking action to reduce the rapid rise in home equity lines of credit, or HELOCs. The government will do this by clamping down on the insurance that Canada Mortgage and Housing Corp. offers to the lines of credit.  Home-equity lines of credit and loans have surged in Canada, rising at almost twice the pace of mortgages over the past decade to account now for 12 percent of overall household debt.

The third measure that will reduce how much Canadians can draw on their home equity. Last February the Finance Department announced that it would lower the maximum amount Canadians could withdraw in refinancing their mortgages to 90 percent from 95 percent of the value of their homes. It is now reducing that maximum to 85 percent from 90 percent.

Observers have been speculating that Finance Minister Jim Flaherty would take steps to tighten mortgage credit in the next federal budget. The timing of the move suggests concerns are growing in government circles about household debt and its impact on the economy. 

CIBC chief economist Avery Shenfeld referred to the mortgage changes as part of a larger move by the government to "force Canadians on a debt diet" as household debt levels sit at record levels.  "Policy makers now have that credit buildup in their policy gun sights, and will use higher rates and regulatory changes to bring spending into better line with income, and cool mortgage demand," Shenfeld wrote in an economic forecast on Monday.  "Canadians aren't on the verge of a U.S.-style default crisis - not at these interest rates, and not with debt having been granted to stronger hands than was the case before America's crisis, when subprime mortgages and credit cards were given out like candy," he said.  "But maintain this diet of borrowing for five more years and debt obesity would indeed weigh down the household sector's momentum. It's time to start the borrowing diet now, and that means policies aimed at slower debt-financed consumption growth and a cooler housing market."

Bank of Montreal's head of Canadian retail banking supported the government's move, since the bank has been primarily recommending mortgages with a maximum 25-year amortization to build more equity and retire the loan faster, rather than paying more interest.  "The actions announced today by Minister Flaherty are prudent, measured, responsible and timely," Frank Techar, president of personal and commercial banking at BMO, said in a statement issued by the bank. "For many months, BMO has been encouraging Canadians to lower their total cost of household debt by paying down short-term higher interest debt and considering the benefits of a mortgage with a 25-year maximum amortization to help them save interest costs and pay down their mortgage faster."

It's not the first time the Conservative government has tinkered with the mortgage market. In 2008, Flaherty announced Ottawa would no longer back 40-year amortizations, with a goal of cooling down a hot real estate market and preventing the emergence of a housing bubble in Canada. At that time, the government said it would also back only mortgages where the buyer has put down at least 5 percent, effectively eliminating zero-down mortgages.

Last February the Finance Department lowered the maximum amount Canadians could withdraw in refinancing their mortgages to 90 percent from 95 percent of the value of their homes. Flaherty also introduced a measure requiring borrowers to qualify for a five-year fixed-rate mortgage, even if they sought a variable mortgage at a lower rate. Until that change, home buyers only had to qualify for the higher of either a three-year fixed-rate or variable-rate mortgage.

The Canadian Association of Mortgage Professionals spoke to the government frequently over the last three months, and was pleased that the changes didn't include any modification to the minimum down payment required to buy a home. And while president Jim Murphy said that he generally approves of the changes to amortization lengths, he hopes the government shows the same willingness to change if the market cools further.

"We understand why he did what he did," Murphy said. "But we hope when the time comes, he'll revisit that decision. Real estate is very important to the economy, and it's crucial that we find a balance because you don't want to overreact to temporary market conditions."

He said a better choice would have been to keep 35 year amortizations, but force all applicants to qualify with the assumption of a 25 year amortization.

CAAMP, which represents the mortgage brokerage industry, released a study late last year that showed mortgage debt in Canada surpassed $1 trillion for the first time in 2010. About 22 percent of all new mortgages had amortization rates longer than 25 years, up from 18 percent the year before.

There was a jump in the number of Canadians using their mortgages to free up cash, with 18 percent taking out equity as the cited a need for "debt consolidation or repayment." The average amount borrowed against home equity was $46,000. Given that there are 5.65 million mortgage holders in Canada, CAAMP estimated the borrowing at $41 billion, about the same as last year.

"It is estimated that 30 percent of the takeout was for debt reconsolidation and repayment," the report stated. "Therefore, while the amount of outstanding mortgage debt would have increased by this amount, totals for other types of debt would be correspondingly reduced. About $15 billion was taken out for renovations, $6 billion for education and other spending, $7.5 billion for investments and $4 billion for other purposes."

With files from Boyd Erman, Tara Perkins and Steve Ladurantaye