By Patrick O’Brien (AIMS on Campus Student Fellow)
The purpose of this article is to highlight some of the recent changes to mortgage regulations/qualifications, and their effects on the economy.
First, we will distinguish between insured and uninsured mortgages. Insured mortgages required a down payment less than 20 percent and the homeowner must pay insurance premiums to the Canadian Housing Mortgage Corporation. This insurance is costly, has no benefit to the homeowner, and only benefits the lending institution. In the case that the borrower defaults, the lending institution will be covered in full by the insurance premiums. Uninsured mortgages have down payments higher than 20 percent, and therefore do not qualify for the insurance because they are deemed less risky.
Starting in 2018, the Office of Superintendent of Financial Institutions (OSFI) has put in place new rules for first-time home buyers looking to purchase a house now need to qualify at an interest rate 2 percent higher than the banks current posted rate. This will result in a 20 percent decrease in house affordability.
How does this affect our economy?
- Fewer housing starts
- Less access to cheap credit
- Decreased consumption in economy.
Majority of new Mortgages come from house resales, compared to new houses being built. Canadian Housing and Mortgage Corporation (CMHC) reports in its 2017 housing market outlook that total home sales will decrease on average by 2% from current levels. Of the total housing sales forecasted in 2018, 39% will come from new housing starts. This could affect the Canadian labor market in many ways:
- Less employment in the construction industry
- Loss of retail jobs, in the construction supply industry (Kent, Home Hardware, etc.)
- Lower growth in sales of heavy machinery/automotive sales required for construction.
How will the changes affect credit markets and consumers? Increasing mortgage application requirements decreases the availability of credit in the economy. After making consistent mortgage payments and building equity in their home, many homeowners borrow against their house to finance current expenditures. They also use the proceeds to invest in real and financial assets, such as: small businesses, additional real estate, and stock market investments. Because borrowing against your house is much cheaper than conventional credit products such as credit cards and bank loans, many people will choose to pay down their existing debts from their mortgage. This is considered a mortgage refinance, or “blending debt” where the debts are added to the mortgage at a lower rate, and therefore increasing the life of the mortgage. In an article by CBC, findings showed that non-mortgage debt (credit card, loans, line of credits, and installment loans) was up to an average of $21,696 in June 2017 for all Canadians, representing an increase of 1.9% from 2016.
When summarizing the overall affect of the change in mortgage regulations, we need to also take into consideration the benefits of the change. Although this standard will affect growth in the economy, it will also stabilize/normalize the Canadian GDP. This is because there will be an increase of goods and services purchases in the economy coming from savings, instead of credit which is considered artificial growth. Also, the new requirements will help decrease the risk of default on mortgage payments, should the housing/labor market conditions worsen.
Overall, I believe the new policy implementation’s benefits of reducing the risk of financial default will offset the decrease in cheap credit for consumers, and the temporary decrease in construction related employment, therefore creating a stronger Canadian economy.