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Here’s a fix for Canada’s high debt burden: raise mortgage rates

Here’s a fix for Canada’s high debt burden: raise mortgage rates

MONTREAL - Along with other signs of spring, hints of rising interest rates are beginning to bloom, reviving the long-running worry that Canadians have run up too much real-estate debt.

While the Bank of Canada steadfastly declines to hint at any rise in rates this year, financial markets are of a different opinion.

A telling sign: the yield on two-year bonds, securities whose effective interest rate is set in the marketplace, has bumped up about a fifth of a percentage point in recent weeks after months of dormancy.

“Accordingly, the odds of Canadian interest rate hikes in 2012 are rising by the day,” probably to more than 50 per cent, calculates Douglas Porter, deputy chief economist at BMO Capital Markets.

While Porter’s opinion isn’t unanimous, the notion that Canadians are probably carrying too much mortgage debt nearly is.

After all, the debt load carried by an average household remains near a record, and even if the Bank of Canada rate remains steady, fixed-rate mortgage rates could well be drifting up as bond market participants become more optimistic about economic growth now that Greece hasn’t imploded and the U.S. is clearly recovering.

Rising yields in bond markets could push up the rate on a five-year mortgage about half a percentage point by year-end, predicts Craig Alexander, chief economist at the TD Bank.

Alexander actually thinks this is a good thing, because a gradual rise in some rates will help to cool the overenthusiastic mortgage borrowing fuelled by years of ultracheap lending.

In fact, he’d like federal officials to toss a little more cold water on a housing market that’s still a little too hot for comfort.

Alexander stresses that this isn’t because he sees any crisis in the offing, but simply because he’d like Canadians to have a little more financial leeway when some shock – perhaps a jump in unemployment or interest rates – eventually does hit.

In fact, home prices, which were shooting up rapidly in recent years, are now reassuringly tame, with the Canadian average up by just two per cent over the past year.

However, the problem is this: even with prices nearly flat, the total number of sales keeps growing, up by 6.7 per cent across Canada in the past year.

More sales means more mortgage loans, so the already-heavy debt burden of Canadian households could well rise some more.

Because of this, it’s probably time to dent the cheap-money psychology that’s become entrenched after years of ultralow rates.

But any big, sudden squeeze could trigger a sudden lurch downward in a housing market that’s probably overpriced by about 10 per cent or so.

Alexander’s solution would be some gradual, steady pressure on mortgage borrowing, carried out by altering lending rules.

For example, the Harper government could complete the withdrawal of foolishly easy mortgage-lending rules it instituted six years ago and has since mostly reversed.

One more step would be to cut the maximum length of a loan to the long-standing rule of 25 years from today’s 30.

This would hike monthly payments a bit, but shouldn’t traumatize buyers, Alexander thinks.

If that’s not enough to cool borrowing, federal officials could raise the minimum interest rate banks use when testing a borrower’s ability to qualify for a loan.

Today, all borrowers must have enough income to carry a mortgage at the current five-year rate, even if they’re actually borrowing shorter and more cheaply.

Alexander would hike this test rate from today’s five-year rate to roughly what a five-year mortgage might cost a few years from now.

That might be 5.5 per cent instead of today’s test rate of about four per cent.

Another possibility would be to require home-equity loans to pass a tougher income test, which would cut maximum lines of credit. And a final resort if other measures aren’t enough: Inch up minimum down payments from today’s five per cent to six or seven per cent.

Porter, however, envisions a simpler solution.

He isn’t sure that a reworking of lending rules is needed and thinks Canada’s economy is strong enough now to envision hiking rates a bit by the latter half of this year.

If the Bank of Canada took this position, he believes, the likelihood of even a tiny hike could be enough to cool markets by shattering some borrowers’ fantasy that rates will never rise.