The federal government has just announced plans to tighten borrowing so as to help cap growing household debt and ensure the stability of the housing market. Changes announced today include requirements for larger down payments on purchases, shorter amortization periods on mortgages and a reduction of the maximum amount that can be borrowed against a home.

Notably absent from the today’s announcement is the more vigorous qualification requirement for condominium purchasers that was reported by the National Post on Thursday and again on Friday as an item under serious consideration. This measure relates to the debt ratio calculation used to qualify purchasers for CMHC-insured mortgages on condo units and called for the inclusion of 100% of the applicable condo common expense fees as part of the benchmark Total Debt Service formula, up from the current level of 50%. This change would make it more difficult for people to qualify for a loan to purchase a condominium unit. For an explanation of the mechanics of Total Debt Service formula and the impact of changing it, see this piece at the Canadian Mortgage Trends blog.

In today’s story on the announcement of the proposed changes, the National Post reports that the government has “no plans to target condominium purchases,” which likely comes as a relief to condo realtors and developers. Not surprisingly, much of the condo industry’s early reaction to the prospect of amending the debt ratio calculation to target condo purchases was unfavourable, citing the negative impact on first-time purchasers’ ability to own a home.

While real estate agents and developers would mount a fierce opposition to any measure that targets the purchase of condominium units, it is pretty hard to argue with the logic of changing the lending formula to include 100% of the condo common expenses when you consider that:

1. How did it ever come to pass that only 50% of common expenses are factored into this equation to begin with? This makes about as much sense as determining financial ability by assuming that prospective borrowers’ income is 150% of their actual income.

2. Common expense fees at new condo developments typically increase quite significantly after the first or second year. In addition, common expenses typically do not decrease from year to year and, thanks to ever-increasing utility costs and the imposition of HST, they probably never will. If purchasers cannot safely carry their mortgage debt based on 100% of common expenses at the pre-sale stage, how can they possibly be expected to manage when common expenses have increased by, say, 30% or more by the third year?

3. Unlike vehicle maintenance or child support, it is not possible to skip paying condo common expenses and get away with it. The fact is that failing to pay common expenses gives rise to a catastrophe as great or greater than skipping mortgage payments. Any condo owner who thinks that paying common expenses is less important than paying their mortgage learns the folly of that assumption in very short order, and it is a costly lesson.

4. Regulators in the U.S. introduced stricter lending criteria for condominiums two years ago. In stark contrast to our system, the American model actually provides that each particular condominium development must be individually qualified for lending, in addition to the prospective purchaser/borrower. See this short summary in the New York Times.

5. The fact that our bubble has not yet burst does not mean that we can continue to tempt fate with impunity. Some argue that now, more than ever, purchasers need to be saved from themselves, lest we face the kind of meltdown that destroyed the American housing market. The government’s statement on the need for such changes and its implementation of a second round of changes to lending rules seems to underline this fact.

According to the Canadian Mortgage Trends blog, striking a balance between imposing some common sense into lending practices and avoiding harmful over-regulation of the market is not easy. There are plenty of factors to consider and that debate will undoubtedly continue for some time, but whether or not government will specifically address the apparent flaw in calculating borrowers’ eligibility for condominium purchases is far from clear.

We can safely assume, however, that the lending qualification formula that has historically considered only 50% of actual common expenses has probably contributed to a significant number of unit owners being over-leveraged. Many such individuals are now in arrears of paying their common expenses and are consequently subject to a condominium lien registered against their unit. Such liens have priority over a bank mortgage and are enforced in the same manner as a bank mortgage, as per sections 85-86 of the Condo Act. The result is that over-leveraged owners may lose their homes, be stuck paying large legal costs to both their condo and their bank, and suffer devastating harm to their credit.

Given the steep downside facing over-leveraged condo unit owners and considering the increasing prominence of condo units as a percentage of all properties sold, tightening the lending rules for condo purchases specifically may offer much-needed protection to prospective purchasers and greater stability to the entire marketplace. The government should seriously consider a move in this direction.