Say goodbye to the 30-year mortgage

If you’re young, with no down payment and looking to buy your first home, you may have just missed your opportunity to break into the housing market. Ottawa is closing the door on 30-year amortization periods and restricting the amount of money you can borrow.

The longest government insured mortgage you can get will now top out at 25 years. Ottawa is also limiting how much you can borrow against your home’s value from 85% to 80% and forcing Canadians to pony up a 20% down payment on homes worth $1 million or more. While the latter changes aren’t dramatic, it will limit how much debt Canadians can hold.

This is the federal government’s third attempt to cool the housing market in four years. In 2008 Ottawa lowered the maximum amortization period from 40 to 35 years; in March 2011 it dropped to 30 years.

If you’re one of those grim-faced future homeowners, I feel for you. In 2007 I took out my first mortgage and stretched it out over 35 years. I wouldn’t have been able to get in the market if the rules were stricter. But with housing prices seemingly out of control it was only a matter of time until the government stepped in.

Just look at the numbers: for every dollar we earn we owe $1.50. Housing prices have doubled in the past decade. Plus, The last time federal finance minister Jim Flaherty reduced the amortization period it was because people were “borrowing to the max and borrowing to the max at low interest rates.” But in a press conference Thursday morning, Flaherty says Canadians still haven’t got the message.

“Our government has taken a series of measured steps to protect long-term stability in the housing and mortgage market and to protect Canadian households from getting over extended,” he said. “(The change) will reduce total interest payments and help build up value in homes and (help people) pay off their mortgage debt sooner.”

For those who are worried about the high debt levels and the state of household finances in Canada this change is good news. It means anyone in the market for a mortgage will be forced to take on less debt and make higher monthly payments.

But the news isn’t so great for those who really want to own a home. “For the average guy, this is going to hurt,” says Mark Fidgett, a Vancouver-based mortgage broker. “It’s tough to buy anyway, but now it’ll be tougher.” Still, Ottawa clearly feels that with mortgages as accessible as they’ve been and with homebuyers demonstrating that they are willing to spend anything to buy a house, home ownership is becoming a dangerous game.

While low interest rates have made homeownership accessible to more people, the concern is what will happen when interest rates rise. Consider the following scenario. Say you have a $500,000 mortgage. If that mortgage was charged an interest rate of 3% and had a 30-year amortization period you could service that loan for about $2,100 a month. If you shorten the amortization period to 25 years that same mortgage would cost $250 more. And if interest rates then jumped to a 5%—which is still modest by historical standards—then suddenly your payments will jump to $2,900. In some cases, Canadians could shoulder the higher payments, but they likely wouldn’t be able to afford anything else.

While the new rules won’t affect current homeowners, it could have an impact on sellers. The change likely won’t crash the housing market but it will be a drag on housing prices. “I was seeing a slowing anyway,” says Fidgett. “This is just going to make it slower.”

In the first month after Ottawa cut amortization to 30 years in 2011, home sales activity fell by 4.4%, although the drop was short lived. Still the 30-year amortization was a long period and there was no immediate indication that interest rates were going to climb. While it’s still unclear when rates will rise, Bank of Canada governor Mark Carney repeatedly reminds us that he could raise rates at anytime. That, coupled with this rule change, could very well cause potential buyers to wait on the sidelines until a correction occurs.

Ultimately, the government had to do something. (Whether Flaherty should have raised amortization periods to 40 years in 2006 is another question, one he, not surprisingly, didn’t address in his press conference.) While you can still overextend yourself with a 25-year mortgage, it’s less likely you’ll run into problems because now you’ll need to be in a better financial position to buy a house.

There is a silver lining for those who have put their home-buying plans on hold. If prices do fall—as many predict they will—you won’t need as much cash to purchase your abode. So, if you can be patient, there’s a good chance you’ll get into that dream home after all.