I get frustrated when I hear comparisons between our mortgage industry in Canada and that of the United States.
We have made important, crucial changes to mortgage rules and regulations, and I’d like to examine a few ideas that experts have for creating a safer mortgage environment going forward…
“If it could happen in the United States, it could happen here in Canada too!”
I’ve grown so tired of hearing that…
Anybody who claims that the mortgage meltdown of the late 2000’s in the United States is a sign of things to come here in Canada has no idea a) what happened in the mortgage industry in the United States five years ago, b) what steps Canada took to change their industry after seeing what happened in the United States.
Canada and the United States share a border, and they are the largest trade partners in the world, but that doesn’t mean that we are joined at the hip in every single thing that we do.
Canada never had the predatory lending practices that the United States put into place, and our investment banks never had the brilliant idea to package sub-prime loans into securities and sell them to the masses.
This was a problem unique to the U S of A, and history shows that we did not follow suit.
But after the mortgage meltdown, the Canadian Mortgage Housing Corporation did bring about some changes that would help stabilize the mortgage industry in Canada, and remove the “risky borrowers” in the process.
We’ve all heard the stories, we’ve all read the books, and we all know the anecdotes; an immigrant cleaning-lady in New York obtains a loan for her fourth investment property in Queen’s. This never happened in Canada, and yet CMHC brought enacted changes to ensure, unequivocally, that it never does.
Here are the four largest changes brought about in the last few years.
1) Amortization Period: 40 Years to 30 Years
I’ve heard other people comment, “They have 100-year amortization periods in Europe, so what’s the problem?”
Well, I don’t want to jump onto that sinking ship, but, isn’t Europe having debt problems right now?
It seems like just yesterday that California introduced their fifty year mortgage! Oh, wait, that was 2006. And nothing bad happened shortly after that, right? Read the article HERE.
A few years ago, CMHC decided to eliminate the 40-year amortization as an option for Canadian borrowers. They cut the maximum amortization down to 35-years.
A few years later, CMHC eliminated the 35-year amortization, thus making the maximum amortization period 30-years, where it remains today.
If a buyer purchased a $500,000 property with 20% down, he or she would pay $328,474 in interest over 40 years, but only $235,926 in interest over a 30 year period (assuming 3.39% interest). But more importantly, the principal/interest ratio goes from 55%/45% to 63%/37%.
CMHC encouraged buyers to take on less debt, pay less interest, and pay off their mortgages quicker.
2) Minimum Downpayment Requirements
I remember selling a $1,100,000 house in 2005 to a client who put down negative equity.
He was on the receiving end of the “107% mortgage financing” package that was available to qualified borrowers. He put down ZERO on the property, and actually received $77,000 back to help pay his closing costs and to do with whatever else he saw fit (buy furniture, take a trip, etc.)
Those times have changed. Dramatically.
CMHC decided that all buyers must have a minimum 5% down, which is something that most people today will look back upon with hindsight and laugh. Most people will say, “Yeah, great ‘decision’ to force people to actually pay to own real estate,” and I wouldn’t blame them. It seems outrageous today to think that once upon a time, people could put down 1% on a property, so long as they qualified.
3) Qualification At 25-Year Amortization
Whether you have a 30-year amortization today, or whether you took advantage of the 35-year amortization periods available up until a few years ago, CMHC rules dictate that you must qualify for your mortgage assuming a 25-year amortization.
Once again, this helps to ensure that minimum standards are met, regardless of the direction the borrower chooses to go, and the interest that he or she decides to pay over the course of the loan.
4) Minimum 20% Downpayment For Investment Properties
This is the most important rule, in my opinion.
The story above about the immigrant cleaning-lady in New York who owned four townhouses is not just an anecdote; it’s a true story, included in Michael Lewis’ book “The Big Short.” If you haven’t read the book by now, what are you waiting for?
But this could never happen in Canada, under CMHC rules.
For any second property, a buyer must make a minimum 20% downpayment.
Brilliant!
This ensures that a cleaning-lady can’t take $50 of every paycheque and pay some administrative fee to a predatory lender who will set her up with a zero-percent-down mortgage to buy yet another townhouse that she can’t afford. Wow, how did nobody see the American mortgage crisis coming?
So if you have a primary residence, regardless of how much money you put down, and regardless of your equity position, you MUST come up with, say, $100,000 to put down on that $500,000 investment property. You can’t just go out and get financing to buy those third, fourth, and fifth properties as you continue on your way toward being a self-described real estate mogul.
This rule helps, more than anything, to ensure that Canadians don’t over-extend themselves and try to leverage a few bucks into a real estate empire that they might not be able to afford one day down the road.
Where Are We headed Now?
As first reported by the Globe And Mail on Friday, Ottawa is being urged by some economists to change mortgage regulations even further.
Craig Alexander, the chief economist at Toronto Dominion Bank, has four recommendations on how to proceed:
1) Cut Amortization Period To 25 Years. This would help return us to a level that was in place in 2006 before the Conservative government allowed for the introduction of a 40-year amortization. It seems like the natural progression from 40, to 35, to 30 will continue down to 25.
2) Approval At 5.5%. Mr. Alexander suggests that anybody looking to obtain a mortgage should show that they could still afford the loan if rates rose to 5.5%, from current rates as low as 2.99%. This is similar to the CMHC rule that all borrowers, whether using a 30-year amortization or not, must show that they could be approved based on 25-years. The approval at 5.5% would help to weed out those that couldn’t afford to pay their mortgages if rates went up, and I think it’s a great idea. Rates were as high as 5.99% in 2007 when many of my clients took on mortgages that are now DOUBLE the rate of what is available on the street.
3) Maximum Home Equity Line of Credit (HELOC). As home prices have increased, so too have home equity lines of credit; both in terms of the number of Canadians who have HELOC’s, as well as the amounts. Mr. Alexander suggests that lenders should ensure that any borrower could pay off his or her HELOC within 20 years. Overall HELOC debt has risen from 11% of all consumer credit in 1995 to 50% in 2011.
4) Minimum 7% Downpayment. The current minimum downpayment is 5%, but Mr. Alexander suggests that increasing the standard to 7% will further help to eliminate those borrowers who can barely afford their mortgages.
The idea is not to bring ALL of these changes into the marketplace at once, as that might trigger a downturn in the economy.
Personally, I have no issue with the 25-year amortization, or the approval based on a higher interest rate. But I don’t know if raising the minimum downpayment from 5% to 7% is necessary. If we’re going in that direction, then go the distance and make it 10%. However, borrowers would eventually find other ways to come up with the money, and lenders would wise-up and invent loan packages that would help provide first-time home-buyers with the funds they need.
But it seems every day, you need only open the newspaper to see that somebody, somewhere, is suggesting that change is needed.
Queen’s University finance professor Louis Gagnon was also quoted in the papers last week as he recommended similar changes.
“Canadians are collectively growing more vulnerable,” he says. Professor Gagnon suggested that the maximum amortization period is reduced from 30-years to 25-years, and suggested that minimum downpayments are increased from 5% to 10%.
“I think the key is equity,” he says. “When interest rates go up, those people who have a low level of equity in their homes will have their equity wiped out.”
It seems that many experts agree that change is needed, and they seem to agree on the same points.
Amortization period and minimum downpayments are what worry experts, although nobody seems to be talking about the qualification process, ie. debt-to-equity ratios, employment history, etc.
In any event, I would welcome almost any change to the mortgage industry, as I too fear that many unqualified borrowers are obtaining mortgages in today’s market. We’re nowhere close to the United States in 2006, but let’s try to be proactive instead of reactive.
The bottom line is: Canadians have far too much debt. I think we can all agree on that.
I think that discretionary spending and credit card debt is the issue, but it’s a lot harder to convince today’s 23-year-old moron not to spend $500 every weekend on nightclubs than it is to enact changes to the mortgage industry and prevent those same people from obtaining mortgages that they can’t pay.
But THAT is a topic for another day. Perhaps a Friday Rant…
jeff316
at 9:07 am
I think they would do well to focus on the downpayment moreso than the amortization to avoid people being underwater with the slightest dip in market. That to me is the real trap, the highest risk issue.
Kyle
at 9:26 am
Great post! I’m hoping some or all of these changes come into effect, but where i think regulators have been completely absent, is in consumer debt. This is the crushing, debilitating stuff that ruins lives. Banks push HELOCS like crack cocaine and the credit card companies hand out plastic like chocolates. I would love to see some stronger rules when it comes to this area and i think the world would be a much better place if predatory lenders such as pay day loans and gold-buyers/mortgage underwriters were wiped out.
Joe Q.
at 9:42 am
David — I agree that Canada’s mortgage industry doesn’t share the former excesses of its US counterpart, but I do think that there are a couple of common elements and pitfalls that we could learn from. A few that come to mind:
1. The whiff of “moral hazard” that comes with government-backed mortgage insurance for lending institutions. For example, the Canadian Mortgage Trends website recently commented that some mortgage lenders offer lower rates to borrowers with smaller down-payments due to the relative ease of re-packaging this CMHC-insured mortgage debt. That’s a pretty twisted incentive, and reminiscent of what went on in the USA pre-2008.
Of course, there is also the whole concept of governments back-stopping mortgages in the first place — which is probably fine if it’s done on a limited scale, but makes you think twice when tax-payers end up guaranteeing the mortgages of so many new buyers with little equity.
2. We in Canada (at least in the big cities, and at least until recently) seem to have adopted the herd mentality of RE euphoria (“buy-now-or-be-priced-out-forever”) that prevailed in the USA around 2003-2006. It’s like there is a total inability to see downside or risk.
3. The psychological and economic effects of RE corrections can be pretty severe (whatever the cause of the correction). Consumer sentiment in the US has turned away from home-ownership, even among financially stable borrowers in areas that have maintained their value. A huge fraction of American home-owners are underwater on their mortgages, which is like an economic albatross around their necks (it chains them to their homes and wipes out consumer spending). This wouldn’t be a problem in Canada if we didn’t have so many recent buyers with so little equity in their homes.
Just some things to think about and learn from.
Joe Q.
at 9:59 am
A few other comments —
1. Buyers must make a minimum 20% down-payment on investment properties, but don’t many investors take this down-payment from HELOCs drawn on their principal residences? The equity on the new property comes out of existing properties — debt ratios stay high.
2. In the past, the CMHC would not insure mortgages above a certain value (which was determined region-by-region — presumably on the idea that anyone buying “expensive” properties should have at least 20% for a down-payment). The CMHC did away with this limit in 2003 and house prices took off. What if the CMHC were to re-instate the limits, requiring larger down-payments for more expensive properties?
3. On the topic of credit-card vs. mortgage debt: while expansion of credit-card debt is dangerous, it primarily affects those who service that debt, while expansion in mortgage debt affects everyone who owns a home. If I buy a big-screen TV this week and you buy the same model next week, the price you pay isn’t determined by whether I paid cash or credit. The same isn’t true for housing: supply is limited, people tend to go to the max, and so prices are determined by how much people can borrow.
My two cents.
Ralph Cramdown
at 10:03 am
While it’s true that Canada never had CDO and CDO2, which were particularly nasty, we had/have a lot of other stuff.
Google “cash back mortgage” and a majority of the big banks’ websites come up, plus some of their alternative channels. There’s “Skip a payment once a year.” As well, there’s downpayment assistance programs operating in several Canadian cities, and first time buyer programs with grants, tax abatements &c. from three levels of government. The message to renters and the unsophisticated is clear: Buy a house, we encourage it, and you don’t need much money.
Bogus rosy scenarios: You did it yourself in this column, David. Calculating total interest paid over 30 years assuming 3.39%? NOT a reasonable assumption. Forecasting future interest rates is normally tough, but when they’re historically low, “higher” is a no-brainer. I don’t subscribe, but there’s a significant fringe that believes we’ll see really high rates and inflation in the near future due to all the cash that central banks have pumped into the system.
Qualifying: I’ve heard tell that banks scrutinize borrowers with 20% down MUCH more carefully than high-ratio types. The difference? at 20%, the bank’s either risking its own capital or paying the CMHC premium itself. With high ratio, if computer says “yes,” it’s the government’s problem. CMHC’s board of directors isn’t exactly stuffed with bankers. OSFI just put out draft regulations yesterday relating mainly to lenders’ ensuring borrowers’ ability to pay. Who can read them without thinking “what, they haven’t been doing this all along?” And oh noes, here come fully amortizing HELOCs!
Subprime: Ads abound for mortgages for new immigrants, bankrupts, people with bad, bruised or slow credit, (what IS that, anyway?) or 0% down. Obviously the product exists, and demand is such that advertising widely makes sense.
It was a great run while it lasted…
JC
at 5:21 pm
Good point Ralph about Qualifying.
There are still a LOT of people (including some who work in the industry) who seem to think that CMHC insurance protects the purchaser. It doesn’t. It protects the bank/lender. If the experience of myself and a brother are any indication, someone going in with 20% down does get looked at more closely than high ratio cases because if something happens, the bank doesn’t have the CMHC insurance scenario to fall back on.
My bank wanted 30% down for an investment property that frankly, I could have paid cash for. I told them to pound sand. The bank rep let it slip that it would have been easier to simply put 5% down and pay the CMHC insurance because then it wouldn’t really be the banks problem if I defaulted on the mortgage. Nice huh?
JC
at 5:11 pm
I have to disagree with at least one point.
Canadians CAN still buy with no money down. I see it frequently through the bank reps at new construction sites. Those buyers that don’t have the initial deposit required by the builder (i.e. $20,000) are given a loan or line of credit by the bank, so they can make the deposits. No money of their own down. Then when the house closes, their mortgage kicks in. (In addition to whatever is left over from the LOC/loan) Some take lines of credit from their existing home to fund the deposit/downpayment.
Now you might say that the banks look at income/credit scores and what have you, but who amongst us doesn’t know someone making really good money that doesn’t have a thing to show for it due to poor money management? Heck I know someone making over 100K a year who defaulted on a 70,000 mortgage to the point of losing the house.
Same with the 20% down wanted by banks for “investment” properties. A lot of people simply take the cash from the LOC/SLOC on their primary residence and use that. I did. Some of the problem in the US stemmed from people using their home equity as an ATM. The banks refer to it as “evergreening”. I call it “digging a hole”.
I think we can all agree that consumer debt is a huge issue in Canada. People rolling consumer debt into mortgages without giving a thought to the consequences. A friend of mine who seems to ignore any piece of advice I offer when asked, (Thank you HGTV!) has a 250,000 mortgage on a property he initially paid 140,000 for with a 120,000 mortgage.
mortgagejake
at 9:17 pm
People can still buy with zero down because of the 5% cash-back deals that are out there, NOT from LOCs etc.
THAT is the easiest way to get 100% financing on your property, because the loan is lumped together (hey, I’ll lend you the 5% AND I will lend you the 95%, you’ll pay me back at a much higher rate!)
Funny part is: it works for some clients, so why not?
As for the down payment from LOC, it’s not very easy unless you know how to hide it, to show the 20% down or even less-than from a LOC. If you’re crafty, sure. But if you walk into a branch and deal with an obtuse person, it won’t be so easy, because the down payment for investment properties CANNOT be gifted.
Allrocks
at 8:42 pm
CIBC and RBC will give you 7% cashback with a 5% downpayment. That’s 102% financing, not that far off from your 107% financing case in 2005! If you sell you have to pay a 5% real estate commission so your equity is wiped out. I would argue anybody who makes a 5% downpayment or takes a cashback mortgage is sub-prime borrower.
mortgagejake
at 9:20 pm
I disagree, a sub-prime borrower is someone who:
has sub600 credit
has no ability to prove their income other than a business licence and a stated income letter
has cash under the mattress as their down payment
has 20% down
a person who does 100% financing (or 102% in your case) is either someone who is:
steered by a greedy agent that they CAN afford it,
OR,
CAN afford it but couldn’t be able to save the down payment and the idea and concept really works for them (i.e. their rent is higher than mortgage for example, they earn great $$$ and have no debt)
As for CIBC and RBC, guess what? that cash back CANNOT go towards down payment so the person still has to have some funds available on closing, as the funds get depo’d the day of or after closing (too late to use for down payment)
(National Bank and Laurentian Bank DO forward the 5% to lawyer so they DO have 100% financing)
Devore
at 12:16 am
Not sure why you’re getting so riled up about this. Any mortgage broker will find you someone willing to give you a mortgage with nothing down. That’s just a fact. And only in the last couple of weeks have major lenders begun eliminating or cutting back on their stated income mortgages.
mortgagejake
at 10:36 am
I am getting riled up because as a mortgage agent myself, I hate the fact that the Government killed 0-down deals AND YET they are still available. The gov’t KILLED 35+yr amortization yet I can get you 40 year.
WTF?
Geoff
at 9:08 am
David – how about responding to some of the very valid counterpoint comments on this posting? Particularly the one that says since the government backs the loans anyway, there’s hardly a lot of incentive for the banks to police their clients?
Joe Q.
at 11:33 pm
Not that there’s necessarily “hardly a lot of incentive”, but that the incentive is greatly reduced due to the externalization of the downside risk.
In any case, with the planned slowdown in the growth of the CMHC’s portfolio over the years ahead, it’s likely to get considerably more difficult for marginal buyers to get a mortgage.
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at 9:17 pm
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