Thursday, October 14, 2010

Generous mortgage terms, low interest rates spark home-ownership boom

By Jane Londerville

The increase in percentage of home ownership in Canada between 2001 and 2006, as documented in Canada’s Vital Signs 2010, is partly the result of generous mortgage terms and low interest rates.

Home buyers were permitted to borrow as much as 100% of the price of their home at the end of this five-year period; those having difficulty saving for a down payment – but with reasonable income and credit ratings – used this opportunity to get into the real estate market .

Households could also extend the amortization period (total time to pay off the loan) to 40 years during this period – and a significant proportion of first-time buyers did this in order to buy a more expensive house.

In 2008, in light of significant default problems among homeowners in the U.S., the Canadian government legislated a maximum loan-to-value ratio of 95% and a maximum amortization period of 35 years. In 2010, further restrictions on borrowing were put in place. For example, households refinancing their home now cannot borrow more than 90%, forcing at least some saving through mortgage repayment and house appreciation.

The main recent change is the requirement that borrowers have sufficient income to qualify for their loan based on the higher five-year-term interest rate, even if they ultimately choose a shorter term or variable rate mortgage. This adds some comfort that they will be able to hang onto their home if interest rates rise in the future when they have to renew their mortgage loan.

Mortgage interest rates have a large impact on affordability of owned housing for Canadians. This is why the ‘price to income ratio’ is not a very effective method of measuring stress in the market. An expensive house at a low interest rate could be more affordable than a lower priced house at high interest rates.

A borrower with a loan of $200,000 at 5% amortized over 25 years will pay $1,163 per month to carry the loan. If, when the term is up on the mortgage loan in 5 years, rates have risen to 8%, the payment increases to $1,526. This is an extra $4,000+ a year in payments. For those who stretched to the maximum when they bought, who have had a child and are now incurring daycare costs, or who have had to replace a high paying job with one at lower salary during the downturn, this change could mean financial strife.

Jane Londerville is Associate Professor and Interim Chair of the Department of Marketing and Consumer Studies at the University of Guelph. She teaches in Guelph's B. Comm. Real Estate and Housing major and chairs the Wellington Guelph Housing Committee which advocates for affordable housing.

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