Ottawa tightening mortgage rules — better late than never
Since most of my posts wind up being the electronic version of fish wrapping, I hope you don’t mind if I repost something I wrote in December 2009 about the impact of 35 year amortization periods for mortgages, and my advice to return to the days of 25 year maxs:
Canada’s housing bubble – time to take away the punch bowl
23 December 2009
Such post-recession excitement.
The price of an average Canadian home is up about 20% year-over-year. Even the mansions in the $7 million plus range are starting to move again. Credit Finance Minister Jim Flaherty for telling it like it is: the time has come to take away the punch bowl.
Did you know that Canada Mortgage & Housing Corp. can swing you a 35 year amortization mortgage with just 5% down on a new house?
Let’s consider the impact of this financial engineering, when it is combined with the lowest mortgage rates in my lifetime. In 1993, a 5 year mortgage would require an interest rate of about 7.25% at a local bank. Although it has been many years since I earned my “personal limits” at Canada’s First Bank, I believe your monthly P+I on a 1993-vintage $300,000 mortgage with a 25 year amortization would have been about $2,155. Assuming you put down 10%, you could swing a $330,000 home (inc. legal fees).
Today, what does $2,155/month get you in the world of 4% five year mortgages, 35 year amortizaton and 5% down? A house worth $512,837…and interest costs of $435k over the 35 year period (assuming the interest rate never changed).
Knock that 35 year amortization back to 1990s standards (25 year am), and, voila, you can only “afford” to buy a house worth $430,192.
A 35 year amortization schedule gets you 19% more spending power in the marketplace ($512.8k home) versus the 25 year style. And you just have to put up another $3,900 yourself; the price of a decent Plasma TV.
What a surprise…the price of an average home is up 20% year-over-year.
In a November report, the Canadian Association of Accredited Mortgage Professionals found 18 per cent of mortgages were amortized over more than 25 years – a gain of 100 per cent in two years. (Hat Tip Globe and Mail)
That 18% equals $82.8 billion of a $460 billion chartered bank mortgage book; which means that more than $41 billion of mortgages have been added in the past two years with a 30-35 year amortization schedule. No wonder prices are up so dramatically.
Canadians shook their heads at former Federal Reserve Chairman Alan Greenspan when he refused to accept any blame for fueling the U.S. housing meltdown. Fortunately, we’ve learned from their mistakes.
Right? Not so fast.
CIBC World Markets economist Benjamin Tal warned Minister Flaherty via the DTM that “any change to mortgage regulations is potentially dangerous…because the government could ‘overshoot’ its goal.” (Economist Tal works for one of Canada’s largest beneficiaries of CMHC mortgage policies.)
Five years from now, if your 35 year am mortgage comes due at even a cheap 5.5% renewal rate, that 95% mortgage on the $512.8k home will cost you an extra ~$410 per month in (post income tax) payments. That represents an additional $9,122 of your pre tax income five years from now.
If you could only save $24,000 to put into the downpayment at the outset of home ownership, how easy is it going to be to part with the additional $9,122 for your pre tax income five years from now?
Time for Minister Flaherty to take away the punch bowl.
Governments live in the real world, or course, and it wasn’t easy to drop from 35 years to 25 in one fell swoop; he had to be dexterious with the fixes (see prior post “Give Flaherty credit on mortgage changes” Jan 18-11). But I’m glad Minister Flaherty’s finally pulled the trigger on this important move.
The new 80% Loan-to-value cap seems strict, when compared to the 90% CMHC limit of 20 years ago. But the sustained price run-up means the homebuyer needs to take on the increased risk of home price deflation, rather than the taxpayers.
Let’s not forget that the Baby Boomers were able to buy their nests with 25 year am mortgages and 7-12% interest rates. This generation of first-time homebuyers will survive these prudent adjustments (provided they aren’t ruined by the demographic changes that might saddle them with unaffordable health and education systems).