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Till Death do you part?

Enterprise magazine
Shannon Rupp

America’s loose-lending habits have caused a credit crisis down south but for cautious Canadian lenders long-term mortgages aren’t about getting the fiscally risky into the housing market but giving preferred borrowers more flexibility.

 The single family home in Vancouver’s poorest neighbourhood, Strathcona, is what the real estate ads euphemistically refer to as “ready for decorating.” The dilapidated two-storey house slouches to one side as if it has lost the will to stand. A pink-and-sludge stucco façade covers a boxy Vancouver special that was obviously the victim of amateur renos, including a rickety staircase with a shaky banister. The aluminum security fence (where white pickets ought to be) barely contains the overgrown grass, but complements the aluminum frames on the two tiny front windows. The features of the 1160 square foot interior --  two bedrooms and one bathroom with lurid pink fixtures – are barely mentioned. It’s not necessary. With a $639,000 asking price the house is a steal in a city where, in February, newspaper headlines screamed that the average home price hit $921,000. Never mind that it sits on the edge of the city’s legendary Downtown Eastside with its colourful collection of hookers and junkies littering sidewalks with needles – at least it’s only 15 minutes from downtown.

At the moment, the West Coast has the most expensive homes in the country. But in the last five years it’s often been a race to see if boomtowns like Calgary or perpetual favourites like Toronto and Ottawa will lay claim to that crown. Even historically affordable provinces like Saskatchewan have seen a rapid upward swing in shelter costs, with average housing prices jumping from $173,000 to $233,000 between 2007 and 2008.

So it would be easy for casual observers to suspect that the escalating cost of housing here is an echo of the financial chaos caused by subprime lending in the U.S. Especially since the federal government announced that, after October 15, it is cancelling the Canada Mortgage and Housing program that insured borrowers for 40-year mortgages with no money down.

When the federal government killed the program in July, the official reason was “to reduce the risk of a U.S.-style housing bubble developing in Canada.” Although in the same news release the government acknowledges that the number of mortgages in arrears is the lowest it has been since 1990.

Put that down to the gap between public perception and fiscal reality.

Robin Eaglesham, treasury specialist at Meridian Credit Union in St. Catharines, said he saw no problem with the 40-year mortgage, because it wasn’t used to bring unqualified buyers into the housing the market -- unlike the so-called “exotic” products in the U.S. that were marketed to borrowers with poor credit history and spotty incomes. He suspects the government’s move had more to do with its concern over international confusion in the face of all the publicity given to the subprime meltdown in the U.S.

“The optics don’t look good in terms of what is happening in the U.S.,” Eaglesham said, explaining that international sales of government bonds are affected by perceptions that the U.S. fiscal problems could be North America-wide. “They can’t be seen to be lenient.”

He said that Canada’s housing market has nothing in common with the American situation, where subprime mortgages represent about one in five loans. (By contrast, less than 5 per cent of Canadian loans go to high-risk borrowers, and the default rate is a third of that in the U.S.)

Eaglesham said that the biggest mistake American lenders made was that after the U.S. real estate boom peaked in 2005 they attempted to keep it going by lending money to high-risk borrowers.  The nicknames for these exotic products say it all: some were called “ninja” loans – that’s shorthand for no job/no income – and there were “liar loans,” which means the borrowers claimed incomes they didn’t prove.

“Before [exotic mortgages] were available only to high-end [borrowers]  with so much net worth. They weren’t designed for people who couldn’t afford to get into the market,” Eaglesham said.

He does agree with the change that requires borrowers to provide at a minimum five per cent down payment because the lack of financial investment can translate into a lack of commitment to the property. But Canadian bankers are famed for doing diligence; he sees no problems with the 40-year mortgages in Canada.

Given Canada’s culture of cautious lenders, Rolie Tippett, senior manager of retail credit at Coast Capital Savings, B.C.’s second largest credit union, was surprised the federal government pulled the plug on the 40-year mortgage. She said it was a useful tool for first-time buyers, who are often stretched thin due to beginning their families and getting their careers off the grown. On Vancouver Island and the lower mainland, where price jumps were huge and bidding wars were common, it also allowed buyers another $20,000 or $30,000.  About 30 per cent of new mortgage applicants chose the longer amortization although they qualified for 25-year mortgages.

“I’m a great supporter of 40-year-mortgages,” Tippett said. “Especially on the West Coast right now: it helps people get into the housing market. But the critical thing is education: [borrowers] need to understand the implications and how to mitigate them.”

“But few people extend out to the full mortgage term – even in 15 or 20 year mortgages. If you accelerate the payments to biweekly, the mortgage is cut to 32 years. They can also make lump sum payments on the principal as their income improves. Canadians aren’t like Americans – they treat mortgages as the priority thing to pay down.”

Tippett points out that Americans are allowed to deduct mortgage interest on their income tax, which gives them an incentive to drag out the payments.

“In Canada there is no advantage if you don’t pay it down. A 40-year mortgage may seem exotic here, but all you’re really doing is changing your cash flow. ”

She added that Canadians borrowers have an additional advantage over Americans in that they tend to negotiate mortgages for three-to-five years, which provides some stability in the event interest rates rise. Subprime mortgages in the U.S. often come with a “teaser” rate – a low interest deal that is good for one year.

Still many Canadian financial advisors and consumer reporters have been scathing about the hazards of long-term mortgages.

Adrian Mastracci, a portfolio manager with KCM Wealth Management, earned headlines when he dubbed the 40-year mortgage the “Freedom 95” plan that will see borrowers paying their mortgages well into retirement because the first 30 years will be spent paying interest.

“The banks will love you because you’re going to be paying for life,” Mastracci told CanWest news. “With a 40-year mortgage you’re not buying, you’re just leasing long-term.”

The Toronto Star’s columnist Ellen Roseman agreed that is one of the biggest hazards She did the math on a $200,000 mortgage at 7.19 per cent over 40 years. With the longer amortization borrowers would reach year 31 before they managed to pay more on the principal than the interest.

In a worst-case scenario, buyers who secured a 100 per cent 40-year mortgage on $450,000 home would have to pay a 3.7 per cent premium to CMHC ($16,650) bringing the cost of the house to $466,650 – which is already more than the home is worth.

“And with a 40-year amortization, it could take a decade or more to repay the CMHC premium, let along make a dent in the mortgage,” Roseman wrote.

In the event of a recession or some other economic downturn, she warns it’s possible for the house to devalue leaving borrowers owing more than the house is worth.

Eaglesham agreed that this is exactly what happened in the U.S., but said it is an unlikely scenario in Canada. 

“In California, homeowners did end up with negative equity. Then people think, `Why should I pay that much when I’m not going to get that much for the house?’ So they just walk away, even if they can afford the payments.”

But he’s quick to point out that Canadian housing prices reflect reality, even in the real estate hotspots. B.C. for example has a booming job market.  Record high commodities prices turned Saskatchewan into the provincial leader in economic growth, which has attracted new residents and fuelled the housing market. In Alberta, climbing energy prices mean gains in real wealth.

“People are moving in and builders are keeping up with demand,” Eaglesham said. Although he adds that the good news is subject to region. The real estate market cooled early in places like Windsor, due to job losses in the auto sector.

Brent Weimer, senior economics and market analyst with CMHC said that even in Ontario, where manufacturing and exports have been hit by the U.S. recession, the housing market is still strong, and housing starts for the first half of the year were still up in the Greater Toronto Area. Fears that the housing boom will be followed by a bust, as it was in the late 1970s, are unfounded.

"The entire economy is not manufacturing and exports to the U.S.,” Weimer said. “About two-thirds of the Ontario economy is related to the service sector – including finance and IT – and there’s more diversity than there was in the 1970s. It’s just not the same picture.”

Weimer sums up the subprime problems in the U.S. as a result of their “strange lending practices.”

“I don’t know any Canadian institution that would have a given money for a ninja car loan, let alone a mortgage. If they don’t have an income they can’t make mortgage payments whether it’s a five-year or a 50-year amortization.”

The International Monetary Fund confirms their views on the stability of Canada’s housing market. They report that in Canada rising house prices are based on sound economic factors such as low interest rates, rising incomes, and population growth. When the federal government announced changes to mortgage insurance in July 2008, it also reported that Canada had the lowest number of mortgages in arrears since 1990.

While lenders do a good job of assessing applicants, it’s also true that Canadians are more conservative borrowers than their neighbours. A 2007 CMHC Mortgage Consumer Survey (MCS) showed that 78 per cent of Canadians who recently purchased a new home intended to pay off their mortgage as quickly as possible, and many were already taking steps to do so.

Michael Leonard, vice president of operations at Halifax’s League Savings and Mortgage Company is also a fan of 40-year mortgages, despite the fact that the East Coast housing market hasn’t been as volatile. He echoed Tippett about longer amortization being valuable for buyers with good credit ratings who need flexibility and are counseled to accelerate their payments. If they weren’t good for members, he said, credit unions wouldn’t be involved with them.

“Credit unions are about providing wise financial advice,” Leonard said. “We wouldn’t be comfortable trying to get members into a 40-year mortgage just because it would make us more money. If we did that, we’d risk losing customers.” 

1 Sep 2008