Canadian Mortgage Changes – CMHC Mortgage Rule Changes

The mortgage market in Canada is changing. In July CMHC announced that they were making some large changes that are in effect October 15th, 2008 regarding a couple of their most popular programs. I read an article this week that explained that something like 60% of Canadians polled did not understand what the changes to the market were and what possible effect they will have. I am going to highlight the two largest changes that have occurred, and explain what the possible impacts of these changes will be.

The two programs that have been cancelled are:

1. Zero Down Mortgages (No Down Payment Mortgages)

2. 40 Year ammortization (40 year mortgages)

A discussion of both of these programs, and my OPINION on their merits, is long overdue:
ZERO DOWN MORTGAGES

Zero down mortgages have only been available (in the current CMHC form) for around 2 years. There was, and still is, a way to make a purchase with zero down, but the rates are higher, and the product is not as accessible as the current form. Under the current form of a 0% down mortgage, the client does not put a single penny up as down payment. They get the full 100% of the purchase price at the fully discounted rates. There is a large CMHC insurance premium that they have to pay, but they are able to get into the market without having to save up a down payment.

This program is being cancelled so that, effective October 15th, you will need to put 5% up as a down payment.

Now, where does this 5% down payment come from? Well, you can borrow it! You can’t borrow it from the same lender and roll it all neatly into a mortgage, but you can borrow it from friends, family, credit cards, lines of credit, or RRSP balances (this last one is complicated but possible). You could also save up the money by way of RRSPs, stocks, cash, or just organic savings over a long period of time. Lastly, there are a couple lenders that offer a 5% “cashback” at closing that gives you a 5% down payment. Note, however, that they charge a much higher rate to do this, and they will insist on you repaying the 5% gift back if you try and sell the property and pay it out prior to the end of the term.

The government is cancelling this program, and the minister has made several remarks that I disagree with likening both the zero down mortgage and 40 year mortgage to the American Sub Prime problem south of the border. This is far from true. In Canada, to qualify for a zero down mortgage, you need a sterling credit rating, and solid, verifiable, proven income. In the United States, you essentially needed 1 of the 3. Just because we are lending the full amount to the borrower, does not mean we (in Canada) are doing so all willy-nilly. In fact, there is an even greater level of scrutiny given to borrowers with zero down, and an even greater level of conservatism with respect to how the banks treat the borrower’s income and credit. Although the data doesn’t exist yet, I suspect that zero down borrowers will be no less attentive to their mortgage payments than borrowers with 5% down. While this is, currently, just my opinion, I believe history will support my opinion. Just because someone put 0% down (instead of 5% down) does not mean they will just up and walk away from the home when the going gets tough. People don’t walk away from their homes unless they have no choice and the 5% vs 0% will do little to prevent this as legal costs of a foreclosure will eat up the 5% in just a couple months.
40 YEAR AMMORTIZATION (40 YEAR MORTGAGES)

Many people gasped and poo-pooed when the 40 year mortgage was announced. Sayings like, “I don’t want a mortgage when I’m 75″ and “you’ll never pay that off” could be heard from many people’s lips (both from outside and within the industry). The reality is that no one will take 40 years to pay off their mortgage, and some common sense should apply here. Also, by cancelling the 40 year, but not the 35 year, the government hasn’t done much as the biggest savings in payments happens when you go from 25 to 35 years and the payment decrease on a 40 year mortgage from a 35 year mortgage is negligible.

What a 40 year mortgage does is:
a. Reduces monthly cash flow
b. Lets a buyer get more house for his money
c. Lets a buyer get into a home he couldn’t otherwise afford

At first blush, C above may sound like, “if he can’t afford it, why buy it?” but the reality is that housing is damned expensive in Vancouver, and we as a society want people to get into property, own their home, and start building equity. It is the only long-term plan for wealth creation that pretty much everyone agrees on. Also, property prices always, in the long run, appreciate, and therefore if we can get a buyer into a home with a lower monthly payment, SURE they’ll only be paying a small amount off each month, but over the years their property will appreciate far faster than they pay it off.

Also, I challenge you to show me one person whose situation is so stable that they will sit with their mortgage for 40 years. Consider this: if you imagine your payments today as an even $1,000 and your income as $50,000 a year, then you are using 24% of your gross income to pay your mortgage. This is a very manageable number. Now, fast forward 5 years, and assuming you took a 5 year term, will your income still be only $50,000 a year? What about 10 years out? 15? Your mortgage payments will remain (relatively) unchanged, and your income will (in most cases) rise throughout your life making that $1,000 seem less and less when considered as a percentage of your income. How long before you start doubling-down on your payments, making lump sums, or paying it off faster? Even more common: how long before your personal situation changes: you get married, you have a child, or worse, get divorced? These are changes that happen in a person’s life, and the 40 year mortgage lets you control (through leverage) a large asset, benefit from its appreciation, minimize the cash flow out each month to hold that property, and afford the other things in life you need to pay for such as education, car payments etc…

The argument that the 40 year mortgage and zero down mortgage contribute to a sub prime style mortgage market does not hold water with me. The government has made these changes, and waxed on and on about how they support the healthy growth of the mortgage market in Canada. However, the 40 year mortgage versus the 35 year mortgage (which is still around) is not that material. Let’s look at how small of a difference a 40 year mortgage versus a 35 year mortgage makes on a $200,000 mortgage assuming 5.25% semi-annual interest:

40 Year payment is $990.17
35 Year Payment is 1,034.19

Difference is $44.02 per month! This small amount, in my opinion, does little to strengthen the Canadian mortgage market, and does little to pay off the mortgage faster. After 5 years, with a 35 year mortgage your balance would be only $2,641.20 lower. Hardly worth squabbling over, when you consider the size of the numbers we are dealing with.

If the government was seriously committed to this action of strengthening the market, they would either leave the programs as they are, or wind back the clock to the 25 or 30 year mortgage. THAT would have a material effect, but they are likely also afraid of the impact that such a move would have on the economy as homeowners that bought their home in the last two years won’t be able to qualify for the property they currently own. The results could be disastrous. Instead, they’ve changed two very small programs that only a peripheral number of people need. I guess my final thought is: why bother?

So there it is. The two changes the government is making along with my personal thoughts and opinions on the changes.

~ by merc359 on August 22, 2008.