Paul Vieira, Financial Post · Monday, Jan. 17, 2011

OTTAWA — The federal government’s move Monday to toughen mortgage rules should further cool housing demand and slow down red-hot renovation activity, while alleviating pressure on the Bank of Canada to raise rates, analysts say.

The measures unveiled by Finance Minister Jim Flaherty are judged to be modest, economists said. Still, they could affect 20,000 home sales this year, according to Toronto-Dominion Bank estimates, as they add roughly $100 per month for future homeowners, driving out potential buyers on the fringe out of the market.

“From a cash flow perspective, the amount of income you have to allocate to buy a home is going up and that will no doubt put a damper on housing demand,” said Michael Gregory, senior economist at BMO Capital Markets.

Mr. Flaherty, amid concerns over record levels of household debt, said Ottawa would no longer guarantee insured mortgages with terms exceeding 30 years, compared to the present 35-year limit. On its own, this move is akin to a roughly 50-basis-point rate increase from the Bank of Canada, Mr. Gregory added. Roughly 30% of new mortgages issued last year were for terms of 35 years.

And as reported Sunday by the Financial Post, the government reduced the maximum amount Canadians can borrow against the value of their homes, to 85% from 90%, on a refinancing; and removed federal government backing for home equity lines of credit, or so-called HELOCs, whose popularity soared in the past decade with growth double that of mortgage debt.

Combined, the moves “will reinforce what we were expecting to be a slower pace of real estate activity over the next couple of years,” said Adrienne Warren, senior economist at Bank of Nova Scotia.

“That could price some people out of the market but it suggests people will have to take on a little bit less debt than they otherwise would.”

For 2011, Ms. Warren said she was expecting relatively flat resale volumes and average prices this year, with housing starts to drop about 8% to 175,000.

A potentially deeper impact could be on the home renovation front as the regulatory changes make it tougher for consumers to use their property to access financing. Those renovations were largely financed by HELOCs, Ms. Warren said.

“To the degree removing [government backing] leads to some impact on HELOC pricing might lead to a bigger impact on renovation activity,” she said.

Expenditures on home improvements, expected to hit a record $44-billion in 2010, have expanded at close to an 8% inflation-adjusted annual rate over the past decade, surpassing the 3% annual rise in new construction or 4% yearly direct contribution from resale transactions, Scotiabank research indicated. A slowdown in renovations could have broader implications on employment levels, given the number of trades people required; retail sales; and manufacturing.

Consumer spending, especially in the housing sector, was one of the key engines of Canadian economic growth as the country emerged from the recession. But the buildup of household debt, to a record 148% of disposable income, is expected to keep consumers on the sidelines. As a result, the economy will need to rely on robust business investment and net exports to drive the economy.

Mr. Flaherty said the measures are intended to ward off a potential consumer debt bubble. “We’re seeing people borrowing to the max at low interest rates,” he said. “And we know interest rates are [eventually] going to go up.”

The Bank of Canada’s benchmark rate is at 1% and is expected to stay there after Tuesday’s decision. But analysts say Monday’s rule changes will result in higher costs for consumer loans without a central bank rate hike -- and such a premature move could have hit key parts of the economy, such as business investment and exports (as higher interest rates fuel upward pressure on the Canadian dollar).

“The Bank of Canada just gained more room to manoeuvre before resuming its tightening campaign,” said Stéfane Marion, chief economist at National Bank Financial.
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