July 10, 2008 / 2:03 AM / 9 years ago

Canada tightens mortgage rules to avoid "bubble"

3 Min Read

<p>A construction worker swings his hammer at a new home development in Ottawa July 9, 2008.Chris Wattie</p>

OTTAWA (Reuters) - Canada tightened the rules on government-backed mortgages on Wednesday to try to avoid the sort of housing meltdown that has damaged the U.S. economy.

The Finance Department said it was reducing the maximum amortization period for new government-backed mortgages to 35 years from 40 years.

It will also require a minimum downpayment of 5 percent for such mortgages; previously, government insurance was available for up to 100 percent of the value of a house.

"Today's announcement marks a responsible and measured approach by the government to ensure Canada's housing market remains strong and to reduce the risk of a U.S.-style housing bubble developing in Canada," the department said, adding that the measures would take effect on October 15.

The government hastened to emphasize that Canada's housing and mortgage markets were performing much better than in the United States.

Canadian housing prices are in line with economic factors such as low interest rates, rising incomes and a growing population and the demand for residential housing remains buoyant at more than 200,000 housing starts a year, it said.

The percentage of bank mortgages in arrears is also stable at 0.27 percent, the lowest levels experienced since 1990 and well below the highs of 0.65 percent in 1992 and 1997.

"The historically prudent and cautious approach taken by Canadian financial institutions to mortgage lending, combined with a sound supervisory regime, has allowed Canada to maintain strong and secure housing and mortgage markets," it said.

It nonetheless noted "accelerated financial innovation" in the mortgage markets since the fall of 2006, for example, allowing loans up to 100 percent of the value of the house and increasing amortization periods to 40 years from 25 years.

The government will now require a consistent credit score for mortgages it backs, and a minimum level of loan documentation standards to ensure evidence of the reasonableness of property values and the borrowers' income.

In addition, government guarantees will not be allowed for high-ratio mortgages where amortization is not required in the first few years -- e.g., mortgages that begin with interest-only payments.

Finally, it will set a maximum of 45 percent on a borrower's debt-service ratio -- the proportion of gross income that is spent on debt service and housing-related fixed or essential payments.

Editing by Frank McGurty

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