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UPDATE 4-Canada tightens mortgage rules, says no bubble yet

* New rules come into force on April 19

* Tightens borrowing, refinancing criteria

* Higher down payment needed on speculative deals

* Reduces pressure on Bank of Canada to hike rates (Adds comments, details)

By Ka Yan Ng

TORONTO, Feb 16 (Reuters) - Canada will bring in new mortgage rules to cool the country’s red-hot housing sector, citing the need to prevent a property price bubble even as it gives assurances the market is stable.

Finance Minister Jim Flaherty said on Tuesday he was concerned that home buyers, tempted by record low interest rates, may overextend themselves and that he also wanted to discourage the “tendency by some to use their homes as an ATM machine”.

“There is no compelling evidence of a housing bubble, but we’re taking proactive, prudent, measured and cautious steps today to help prevent a housing bubble,” Flaherty told a news conference in Ottawa.

While the U.S. housing market has struggled to recover, sales and prices of existing homes in Canada soared last year, boosted by the Bank of Canada’s near-zero interest rates and the resulting low-cost mortgages.

For December, sales were up 72 percent from the year before when activity dropped to the lowest level in a decade. The average price of a home was at C$337,410 ($323,190) in December, up 19 percent year-over-year.

And many in the industry had forecast further strength in 2010. [ID:nN08187539]

Flaherty announced three changes to the rules rules for government-backed insured mortgages, designed to prevent the kind of problems that caused the U.S. housing market to collapse, triggering the global financial crisis. [ID:nN16216524]

The rule changes, which come into force on April 19, will require borrowers have the resources to qualify for a five-year fixed-rate mortgage even if they decide on a lower-cost variable rate mortgage.

The government will also lower maximum amounts that can be withdrawn when borrowers refinance mortgages. The maximum will now be 90 percent of the value of the home, down from 95 percent.

Ottawa will also require a minimum down payment of 20 percent for insured mortgages tied to properties purchased as speculative housing investments not occupied by the owner.

As housing prices and sales gather speed, some economists have warned of a housing bubble in which home buyers take on more debt than they will be able to handle when interest rates rise, leading to an eventual collapse that could hamper Canada’s economic recovery.


The rule changes could bring on a new burst of activity as consumers race to get into the market ahead of the April 19 changeover, moving sales forward from later in the year.

“The implications of this are that Canada’s housing market should first turbocharge over the next few months before the April 19 implementation date, then cool sharply, and then resume a more modest rate of ascent,” said Eric Lascelles, chief economics and rates strategist at TD Securities.

“In theory, home prices should take a mild hit immediately, as the number of Canadians capable of financing a home will dip slightly.”

Flaherty described the housing market as “healthy and stable” and said that the government’s action can help prevent negative trends.

Bank of Canada Governor Mark Carney said recently he did not see evidence of a housing bubble, downplaying fears of a Canadian version of the U.S. subprime mortgage meltdown. But the bank has expressed concern about high household borrowing levels and told Canadians to prepare for eventual rate hikes.

There had been calls for the Bank of Canada to step in and raise interest rates to cool the housing market, though the central bank has said its monetary policy is tied to inflation, rather than just one sector of the overall economy.

Still, Lascelles said the new rules reduce pressure on the central bank, and the market will likely need to price out "a smidgen" of nearer term rate hikes. BOCWATCH

Scotia Capital economist Derek Holt said the need to qualify for a five-year fixed-rate mortgage will have a dampening effect. Banks now test using a three-year fixed-rate mortgage. Holt said five-year fixed rates are about 1.1 percentage points higher than the three-year rates.

“The other rule changes are more about optics than about any potentially significant effects,” he said.


The changes add to other moves the government has made in the last few years after housing markets other countries, notably the United States, went into a tailspin because of subprime mortgage lending.

That sort of risky lending had never been a large slice of the Canadian market, but Ottawa moved in 2008 to pare back the maximum amortization period for new government-backed mortgages to 35 years from 40 years, and said it required a minimum down payment of 5 percent, where none was previously needed.

The Canadian Real Estate Association approved of the mortgage rule changes, and continued to warn that annual comparisons are being distorted by recessionary activity from a year ago and the subsequent rebound.

The Canadian Association of Accredited Mortgage Professionals said most people will still continue to qualify as they do currently for homes they intend to live in and that overall lending risk levels are contained.

“We’re pleased in the sense that the minister didn’t overreact. We were concerned that there could be other changes around down payment for principal residence amortizations, other things that would really cool the housing market,” said Jim Murphy, chief executive of the industry group.

Some lenders, including Bank of Montreal BMO.TO, and Toronto-Dominion Bank TD.TO were quick to welcome the rule changes.

“I think this is quite a good move and at the right time. Canada has been well served by our regulator and our finance minister over the last few years, and so this is a pretty good move to keep us out of the soup,” said Tim Hockey, chief executive of TD Canada Trust.