If you haven’t heard already, you’re going to need to read this.

Last week, changes were enacted by the Canadian Finance Department that will revamp Canada’s mortgage industry.

Of all the decisions and changes our Canadian government makes, this is the best one I’ve seen in a long time…

Sometimes people listen to what I say about the real estate industry and they take it with a grain of salt.  They may think “Well what is he going to say; he’s in sales!  Of course he’s optimistic!”

People are constantly asking questions about the real estate market of the United States and how that affects our market in Canada.  Now I don’t profess to have a Ph.D in political science, and perhaps my comments are are founded on little other than my opinion, but I’ve always maintained the Canadian government would NEVER make the same mistakes as the government south of the border.

I don’t want to get into a political debate here, but I just think that our two countries are being run differently, and while the United States is more concerned with “important” issues such as banning gay-marriage and fighting wars in other countries, our government seems more focused on the matters that affect us most, such as those concerning our financial markets, economy, and subsequently our cost and standard of living.

I’ll leave that one open for debate…

But after the United States economy has run itself into the toilet, people are constantly asking “Is Canada next?”

Last week, the Finance Department stepped in and made changes to the Canadian mortgage industry that act as a proactive measure to ensure that our real estate market remains healthy and doesn’t befall the same fate as that of our southern cousins.

There were two main changes to make note of:
1) The Finance Department will stop backing mortgages with amortization periods longer than 35 years as of October 15th, 2008 (some lenders have already stopped giving the 40-year-mortgages as of today, since it’s an inevitability anyways).
2) They will start demanding a down payment equal to at least 5% of the home’s value; thus eliminating the so-called “no-money down mortgage.”

For those not familiar with mortgage fundamentals, consider that a “traditional” mortgage has always been amortized over the course of 25 years.

In 2006, the 40-year mortgage was introduced in Canada with rave reviews as it allowed borrowers to spread out their payments over a longer period, thus decreasing their monthly amount payable.

How popular are the longer-term mortgages?

Well, consider that in 2007, a total of 37% of all new mortgages were for terms of longer than 25 years.

But as worries about the Canadian real estate market began to mount (worries brought on by the United States market, even though the Canadian market is healthy), experts began to analyze the system we have in place and look for weaknesses and ways in which our market might be vulnerable or susceptible to the problems recently encountered by the United States.

The Finance Department identified these new long-term mortgages as part of a policy of “risky lending practices” that got the United States’ market into trouble.  They decided that the amortization periods for these long-term mortgages, while great in the short term, were hurting borrowers in the long-term and lulling people into a false sense of security.

What difference does the amortization period make on the principal and interest portions of the mortgage?

Well, let’s assume a buyer of a $500,000 house is putting down 20%, and is left with a mortgage for $400,000.  What we’re interested in here is the amount of interest the buyer pays under two different amortization periods:
1) 25-year amortization equals $297,243 in interest on the $400,000 principal.
2) 40-year amortization equals $518,062 in interest on the $400,000 principal.

With the longer term mortgage, the buyer is paying over $220,000 MORE in interest!

Or look at it from this perspective: what does it actually cost for your $500,000 house?
1) 25 year amortization: $797,243.  ($100,000 down payment + $697,243 in mortgage payments)
2) 40 year amortization: $1,018,062.

Wow.

It costs you over $1,000,000 for your $500,000 house when you amortize the mortgage over 40 years (for all you finance gurus reading this, please email me with your thoughts on the time value of money, opportunity cost, etc.)

One lingering question remains with respect to the changes from the Finance Department: Why?

Especially when you consider that the percentage of bank mortgages in arrears is stable at 0.27% near the lowest levels experienced since 1990 and well below the highs experienced in each of 1992 and 1997.

What are the reasons?

Perhaps it’s a topic for another day.  A day like……tomorrow!