You Can Still Get A Lot Of Loan

Canadian Finance Minister Jim Flaherty was quoted recently:

"Speaking on CBC Radio, Flaherty said he had no plans to take further action to take froth out of the housing market, after a series of moves to tighten conditions for mortgage lending. The most recent change was in July.
“We’ve done enough, I do not intend to do any more,” Flaherty said, adding that he was pleased at signs of a slowdown in key sectors of the market, like the condo market in the big cities of Toronto and Vancouver."

The government, through OSFI and CMHC have enacted a series of changes to mortgage underwriting guidelines and mortgage insurance qualifications so as to attempt to make credit more dear. I believe the most recent efforts have been made more urgent because real rates on the 5 year bond have been negative for several months.

An interesting exercise is to compare how much loan a borrower can get for a conventional 5 year term mortgage amortized over the maximum allowable, assuming debt service ratios and incomes are flat. To show this effect I have calculated the maximum loan amount a borrower can take assuming a fixed payment and fixed income. I have normalized the results. This shows the effect of amortization and interest rates on how much loan can be taken:

In 2000 interest rates were higher than today and then fell through most of the early 2000s. In late 2006 the government changed maximum amortization lengths to 40 years. This was subsequently pared back to 35 years in 2008, then to 30 years in 2011. In addition there was a change where insured mortgages must qualify under the posted, not actual, rate. Finally, in July 2012 the government reduced maximum amortization length to 25 years on insured mortgages only. (Uninsured mortgages can still obtain 30 year amortizations.)

Despite the recent round of amortization pullbacks the maximum affordability is still well above levels seen in the early 2000s. Compared to January 2000, a borrower can obtain 32% more insured loan and 61% more uninsured loan.

The gap between uninsured and insured mortgages is stark. If prices are coming off their highs and continue to show weakness, uninsured loans will start to become insured as loan-to-value (LTV) ratios start increasing. Given the discrepancy between uninsured and insured loans, that will hit the market hard, so hard I expect a reversal of recent moves to tighten lending, in some form, if prices continue to trend weaker.

While the government may want to protect the interests of taxpayers from future liability, if it's like any other asset bubble in history, that goal is likely not realistic. In my view the question has always been how the government is going to have Canadians consume (read: eat) poorly-performing mortgage debts.