Sun
It may be a black day for real estate agents, but the federal government crackdown on mortgage lending is good public policy that reduces risks to the economy, to taxpayers and even to potential home buyers who will find themselves locked out of the market.
In recent years, the mortgage market had become a free-for-all that allowed buyers to put no money down, pay interest only for 10 years and extend amortization periods to 40 years. Some financial institutions permitted buyers to tack on closing costs, such as land transfer and legal fees, raising the amount of the mortgage well above the value of the property. These mortgages required government-backed insurance from Canada Mortgage and Housing Corp. or a private-sector insurer, shifting all the financial risk to Canadian taxpayers.
The Vancouver Sun has sounded the alarm several times over the last few years. In his Everybody’s Business column of July 21, 2006, Harvey Enchin wrote: “Home ownership should lead to security and stability, not life on the edge.” He said paying interest without building equity was a financial plan built on a flimsy foundation. An editorial on May 10 this year warned of “future shock” if highly-leveraged buyers ran up against a market slump, higher interest rates or income setbacks.
Bank of Canada governor Mark Carney and his predecessor David Dodge both warned that the new mortgage products could fuel inflation and drive house prices higher rather than make home ownership more accessible. They were right to be concerned.
Last year, 37 per cent of new mortgages were for terms longer than 25 years as buyers sought to buy more expensive homes than they could otherwise afford and to lower their monthly payments. However, as the Sun articles pointed out, the insurance premium on a $450,000 mortgage with no money down and a 40-year amortization would add $16,650 to the purchase price. At current interest rates, it would take a decade to pay off just the insurance premium and 30 years before the amount paid in interest dropped below the amount applied to principal. While longer amortization periods reduce monthly payments, they dramatically increase the cost of a mortgage over its lifetime.
The lessons of the sub-prime mortgage crisis in the United States were not lost on Canadian policymakers. Giving money to borrowers who don’t qualify for conventional mortgages and have no stake in their property is a recipe for trouble. Last month, one out of every 501 U.S. households received a notice of default, auction sale or bank repossession and the number of foreclosures was up 53 per cent from a year earlier. The percentage of mortgages in arrears in Canada is low and stable at 0.27 per cent.
Canada was not likely to experience anything like the U.S. sub-prime loan crisis that spawned a derivatives debacle still reverberating in credit markets today, but this week’s move by the Department of Finance was necessary and perhaps overdue.
The new rules set a minimum down payment of five per cent on all mortgages and require that insured mortgages have an amortization period no longer than 35 years. It also establishes a minimum credit score for borrowers.
These moves will help ensure that home buyers are not over-extended, that Canadian taxpayers are not put at greater risk of mortgage defaults and that an overheated housing market — already cooling — doesn’t add to inflation.
© The Vancouver Sun 2008
