Ball Gazing

We received a memo this week from a large brokerage.  We'll keep their name under the rug in case they don't want the publicity.  It talked about what to expect once the government's new loan-to-value and amortization limits take effect.  We thought we'd pass along it's more salient points.

In no particular order:

• A fair number of Canadians currently rely on 40-year amortizations and $0-down programs to qualify for a mortgage.  The source suggests the upcoming absence of these programs will reduce demand for housing temporarily (but not substantially).
• The federal government's move may stimulate price competition among insurers.  That's because #3 insurer, AIG, as well as lower tier insurers, may have to cut premiums to maintain market share (a lot of AIG's share is currently attributed to 100% financing and 40-year amortizations).
• "Opportunities will emerge" in the "Alt-A" and "B" lending markets as insurers pull out of this segment.  For example, a lender with investors (i.e.  a way to securitize its mortgages) may find it attractive to cater to folks with 580-619 credit scores.  People with these scores currently qualify for insured mortgages in many cases...but not for long.
• According to our source, "The Banks will be the first ones to start promoting non-prime and Alt-A as their conduits are still operating and it’s a market segment they would certainly like to ingest."

A few more thoughts from our end:

• The median Canadian family makes $66,343 a year according to the last census.  Other things being equal, that's enough to qualify that family for a roughly $328,300 house--if they choose a 40-year amortization. (assuming prime rate and $3,000 a year for property taxes and heat)
• If, however, the family can now access a 35-year mortgage at most, the maximum they can qualify for drops to $312,615.
• The moral is, if you need a 40-year amortization or $0-down loan, buy soon.  5-6 lenders have already pulled 40-years and $0-down mortgages from the shelves, and the other lenders could do so at any time as well (even before the October 15 transition). 
• Don't be surprised if a lot of people start thinking this way.  In fact, it could actually create a small rush to buy in the short-term. 
• In the medium-term, the changes could potentially have a slight negative effect on house prices for the reasons alluded to above.  (i.e.  people on the fringe can't qualify, or qualify for as much)
• Long-term, the changes could either help the market (by encouraging more conservative lending) or hurt it (by forcing marginal borrowers into pricier extended financing methods).
• All this said, experts predict the impact to borrowers will be reasonably small.  TD economist, Pascal Gauthier, for example, notes that the average Canadian's mortgage payment would increase just $55 a month with a 35-year amortization, versus a 40-year.  (via Ellen Roseman at the Star)

Comments

[Traciatim]

"The moral is, if you need a 40-year amortization or $0-down loan, . . . " Don't buy at all, you can't afford the house. That's the point of the change is that people are using that scenario to buy houses they can't afford.

I don't know about you but 3000 for heat and tax to get in to a place with a $66,343 income seems a bit of a stretch. Actually, I think in Toronto the property tax alone on a 350K place would be over 3000 per year.

[Canadian Mortgage]

Hi Traciatim,

Thanks for the comment. It should hopefully go without saying that people shouldn't be buying what they can't afford. I don't think any reputable professional would ever advocate that.

The fact that a borrower chooses a 40-year am or $0 down doesn't necessarily mean they can't afford the property. It could simply mean that they have better uses for their capital or want more flexibility for whatever reason. Or perhaps they're buying a long-term rental property where leverage is desirable, etc.

People in these cases should act soon, as we've noted, if they need a 40-year am or $0 down.

As for $3000, that's a ballpark assumption. Heat and taxes will differ dramatically depending on the property type and location, and I don't know of a data source for nationwide averages (perhaps someone out there does?).

Cheers,
Rob

[Ryan]

One more thing to note with these 40 year mortgages and 0$ down, they allow high risk people to walk into an expensive house with no vested interest in it whatsoever. What happens when the market turns sour like it did down south. This is the reason why you are seeing so many people in the U.S. simply walk away from their homes. They put 0$ down and basically paid rent for a few years. Now the house is worth far less than they had mortgaged it for and so the easy thing to do is walk away.

I can't imagine why these types of mortgages ever existed other than to keep the farce going. Keep prices rising, keep sales churning and keep everyone believing that a 2000 sq ft house is worth half a million dollars when based on salaries it should be worth half that.

My 2c

[jp]

I don't think any discussion about the legitimacy of 40 year mortgages is complete unless you talk about rising life expectancies too. Is the 40 year mortgage excessive considering we now live to 78? At the beginning of last century it was 49 years. What terms were they using then? 10 year mortgages? 15 year? This debate needs to be framed in terms of the ratio of the longest mortgage term to average life expectancy.

[Whistler]

As long as CMHC was insuring secured high ratio line of credits with interest only payments, they technically were insuring infinite amortizations....which I never had a problem with. In fact, by giving clients maximum flexibility on their payment amount, they likely were stabilizing the market and decreasing payment delinquencies.

100% LTV's on the other had were a horrible idea from the beginning. They encouraged financially immature people to enter a market with no previous demonstration of saving ability. Furthermore, they were ALWAYS actually 103%-104% LTVs in practice after the CMHC premium was added. That necessitated a capital gain on the property in order to break the mortgage within the first two years (and that assumes no prepayment penatly for the mortgage itself). Historically, even though real estate has proven to be a good investment, it has not exhibited straight-line appreciation. Giving non-savers negative equity off the bat was a recipe for disaster. I suspect we will be hearing about the "100% vintage" in the coming months/years, as they are unable to sell their homes for what is owed, and they end up walking away unable to close legitimately.

Shame on the lenders and brokers who dealt these products.

[Al]

jp,

For me it's not how long you're repaying your mortgage in relation to your life expectancy, but how much you're paying in total. The longer amortizations cost way too much, especially at the beginning (>80% of payment being interest.) There is the old argument that when you rent, you throw away money. But when you pay interest you do the same thing. Longer amortization = more interest. People don't seem to get this.