After almost a week, most stories would be considered “old news.”
But the debates, discussion, and analysis continues and will probably do so for some time.
Today, I’d like to continue where we left off yesterday and look at the cause and subsequent effect…
I left off yesterday’s post with this telling statistic:
The percentage of bank mortgages in arrears is stable at 0.27%, near the lowest levels experienced since 1990.
So perhaps this begs the question of why the changes came into place.
Well, looking at the real estate bubble in the United States, the cause can be traced back to the money supply. Lenders were lined up to give out money and offering sub-prime mortgages. This in turn enabled people who shouldn’t be able to get mortgages, to get mortgages!
People who lenders at one time might not have approved, ended up getting huge sums of money that they might not have qualified for under the mortgage rules and regulations of yester-year. Now whether it was irresponsibility, nativity, or unsophistication on the part of the borrowers that caused them to default on their mortgages is anybody’s guess.
But the fact of the matter remains that the trickle-down effect from the sub-prime crisis was felt all over the country. Financial institutions that backed these mortgages lost billions of dollars, and the United States economy took one on the chin.
But our Canadian government obviously learned from the huge blunders of the United States and has taken measures to ensure that Canada doesn’t follow suit.
Some critics are calling the changes “minor” and predicting that they will have little effect. I couldn’t possibly disagree more. That’s like saying there’s no point in feeding a starving child for a week if you don’t have the food to keep feeding him.
Any change is going to have at least some effect, and if these changes keep a few people out of the market that shouldn’t be in it, then all the better.
Let’s work through an example and see just how the rules can be used to one’s advantage…..or disadvantage.
Take a young man who is renting for $1400/month and decides that he wants to get out the rental rut and buy a condo.
But there is only one problem: this young man has ZERO savings!
No problem! With the no-money-down mortgages, this guy can get a loan without investing a penny of his own money!
So he finds a suitable condo for $300,000 and calculates that the monthly payment with a 25-year amortization is going to be $1,743/month. Ouch! He is currently paying $1400/month in rent, and he just can’t afford the jump.
No problem! With the 40-year-amortization, he can reduce these monthly payments to just $1,434/month!
Now, he can afford the condo!
But do you see the problem here? Because I do.
This is a short term solution for a problem that isn’t really a problem in the first place—the fact that he can’t afford to buy!. Some people just aren’t in the right stage of their lives to purchase a property, and that is what the rental market is for! By bending the rules to allow these people to purchase, the short term “gains” are massively offset by the long-term repercussions.
Consider that in the example above, the interest paid by this young man on his $300,000 condo is as follows:
1) 25-year-amortization: $222,932
2) 40-year-amortization: $388,546
The bottom line here is as follows:
Short Term: He pays $1434/month instead of $1743 and can afford to buy the condo
Long Term: He pays $165,614 more in interest over the course of the mortgage
I cannot unequivocally state that this is a bad thing; it’s just my opinion that it is. I personally believe that this young man is better off waiting until he can actually afford to buy a condo before he goes ahead and buys one, but perhaps there is more to his situation that meets the eye.
The reason that lenders began offering the 40-year-amortization in the first place is because of how competitive the mortgage industry became. Lenders fought one another to claim clients and began to develop new products for the lower-run clients.
But here is a question for everybody, and depending on your political or social views, your answers will vary: should EVERYBODY be able to qualify for a mortgage?
I think that lenders would answer a resounding, “Yes!” But they do so because they want more business and more money.
A socialist would answer, “Of course!” But those might be the same people who believe that those unfortunate souls collecting welfare should be able to afford whatever groceries and consumer expenditures they so desire. These critics might believe in equality so much that they neglect to see that those on welfare are poor, and perhaps they can’t afford luxuries.
Because if the lenders were successful in convincing us in “equality” and that everybody should be able to qualify for a mortgage, even those making $10/hour, how long before the 50-year-amortization? Or how about a lifetime-amortization?
I wrote a blog article a while back where I analyzed the movie “Maxed Out” which shows how American creditors feast on the unsophisticated and naive. Click here. MONEY is perhaps the most complicated aspect of our collective lives as a society, and issues with money can spiral out of control if we let it.
But the Canadian government stepped up to the plate and dealt with a potential disaster before it reached “alarm” status.
I would never have advised my clients to take a 40-year amortization, and I won’t advise them to take a 35-year either.
The 25-year mortgage is called a “traditional” mortgage for a reason, and in this case “traditional” isn’t used in the family-values sense, but rather what is sensible and reasonable, in my opinion.