Mortgage rules a temporary fix to housing

People walk past new homes that are for sale in Oakville, Ont., April 14, 2009. TD Bank says tighter mortgage rules should do the job of cooling Canada's hot housing market in the short term, but higher interest rates will be needed to return the market to saner levels. THE CANADIAN PRESS/Nathan Denette

The bank's chief economist Craig Alexander estimates the new rules, which went into effect July 9, will shave five percentage points off sales activity and cut prices by three per cent on average during the second half of this year and early 2013.

In the next three years, he expects the combination of the tighter rules and anticipated modest increases in interest rates will result in a 10 per cent price correction on homes.

While it is early, there are already tentative signs that the new rules have tempered sales, if not prices, especially in the country's hottest markets — Toronto and Vancouver.

The Toronto Real Estate Board reported Thursday that sales of existing homes in the greater municipal area fell 12.5 per cent from last year, although the average price of $479,095 was 6.5 per cent higher.

Meanwhile, the Vancouver board said sales dropped 30.7 per cent in August, while the average price was only 0.5 per cent lower at $609,500.

In July, Finance Minister Jim Flaherty reduced the amortization rate on new insured mortgages to 25 years from 30, bringing the maximum period for paying off a home back to the historic level. It was the fourth time Flaherty had tightened mortgage rules in as many years, incrementally dropping to amortization period from the high-water mark of 40 years.

Alexander says the latest moves, which hike mortgage costs by $140 a month on the average priced home, may be even more effective than the previous efforts in slowing the market.

But if the experience of the previous three moves are any guide, the slowdown will be temporary, lasting a few quarters, after which Canadians will dive back into the market.

For a longer lasting solution to the overheated market, Alexander said Bank of Canada governor Mark Carney will need to hike interest rates to make borrowing more difficult and expensive.

"Interest rates simply cannot stay at current levels indefinitely," he says in the paper.

On Wednesday, Carney kept the trendsetting policy rate at one per cent, marking two years that it has remained at the super-low level, and few economists expect him to act before mid-2013.

Canadians have taken advantage of the cheap borrowing costs to buy homes, cottages, cars and other consumer items, but the result is that household debt has hit record levels at 152 per cent of disposable income.

Alexander says debt would even be higher if Ottawa hadn't begun tightening mortgage rules in 2008.

"Our models suggest that had the government not tightened mortgage rules between 2008 and 2011, the Canadian household debt-to-income ratio would have reached 160 per cent this year," he said.

That's about the level the U.S. and the United Kingdom reached before the collapse, although not all factors are similar.

Alexander says he believes the latest rule changes would trim about one percentage point off credit growth.