When an unsuspecting virgin, like Jane, buys a hipster condo for $400,000 with 5% down that mom gave her, bankers smile. Life is good. The profits will continue.
In Canada any real estate bought with less than a 20% down payment is considered ‘high-ratio,’ and must be insured against jinglemail. That’s the famous phrase coined at the height of the American real estate jam when defaulting property owners would simply put their keys in an envelope and mail it back to the banker. Then plunging real estate values were his problem.
Being a civilized people, we Canadians have taken a different approach. After letting people without any money buy absurdly expensive homes, we require the lender to be insured against the owner taking a walk. That insurance is provided by the government agency known as CMHC, which is backstopped by the taxpayers and now controls 70% of all the mortgages in Canada.
The lender then passes the cost of that insurance on to the buyers. Now Jane has to ask her mom not only for the 5% down, but 2.75% of the mortgage amount for the insurance to cover the bank (not her). In this instance, that would be about $10,500. Of course, mom will refuse because it’s a lot easier to just add tet amount to the mortgage – which is what 99% of borrowers do.
The mortgage, of course, is amortized over 25 years. If Janey were to own the condo that long, she’d pay back about twice the premium, although the bank only paid it once to CMHC. Now multiple this by roughly 100,000 transactions a year, and you can see why the banks love CMHC. If Jane moves on after three years and sells the condo to a new hipster, then another CMHC premium is generated.
So, letting people buy properties with huge leverage and little cash not only keeps the market alive, it also helps inflate real estate prices at the same time it transfers the risk for this (after all, prices don’t rise forever) squarely on the taxpayer. That’s us. These days we’re on the hook for about $560 billion in outstanding mortgages, most of them high-ratio, which simply means ‘high risk.’ Or, in technical terms, ‘holy crap.’
By the way, $560 billion is almost twice what CHMC insured just a few years ago, and not much less than Canada’s total current national debt of about $605 billion. There’s absolutely no doubt federal mortgage insurance has turned a housing boom into a gaseous mama of a bubble by removing risk from lenders. That’s why cashless young Janey can borrow funds at exactly the same rate as the 50-year-old putting 75% down. All she need do is add the CMHC premium to the mortgage principal.
Now the government is worried. F & the Peckerettes, the same guys who helped create this housing Hindenburg when they brought in 0% down payments (before thinking better of it a year later), are recoiling at the monster they’ve unleashed. Days ago the feds announced that starting in three weeks CMHC will have to pay the government a 3.25% ‘risk fee’ on all of the insurance it writes for people like Jane.
Guess what that’s for? Yup, you’re right – to build a fund which will protect taxpayers when the housing market slides into its inevitable correction, and default rates rise. The move is expected to generate about $50 million a year, and also raise mortgage costs by about a tenth of a point.
And there’s more. On Friday the new-and-improved F told reporters CMHC “has become something more grand, I think, than it was intended to be.” Duh. The agency was created after WW2 to help soldiers buy houses. Now it subsidizes and protects massive banks against the risks of a blubbery real estate dirigible it created, by jeopardizing the public. Very smart.
Even the erudite dudes at the International Monetary Fund has this one figured out. They’ve been urging Ottawa to offload a lot of this risk onto private lenders, because everybody (except the people living in this delusional country) expects the Canadian housing market to pfft.
New guidelines for mortgage insurance are being drafted now by the regulator, but probably won’t come into effect for a year. In the meantime, the feds are praying the real estate market does not swoon under the weight of record personal debt, coming increases in fixed-rate mortgages, tens of thousands of new condos and a comatose economy.
Of course, in a regular country run by people who cared about the future, taxpayers would not be subsidizing children without savings who expect nicer houses than their parents ever had, or banks that already earn a billion every 90 days. Then houses might cost what they should.
But it’s not. Jane votes. So does her mom.
One of life’s simpler rules is to closely watch what others do, and do the opposite.
Most people freaked in 2009, sold their mutual funds in a panic at firesale levels and ran screaming into the void. Most people buy things because they’re popular, which makes then rise in value. (They’re popular because they are, well, rising in value.) Most people want houses when markets are hot, then shun them when prices and sales fall. People lined up in the lobby of my bank tower to buy gold at $1,900 an ounce. Today bullion’s $1,200. No line. Most people have borrowed a lot and saved little. Most people are financial cripples, though knowledge is but a click away.
And most people are locking in their mortgages. Eighty per cent, in fact. Not smart.
Despite Friday’s middling job numbers in Canada, the economy’s a sloth. Exports are down, layoffs are up and we’re more a country that builds condos than manufactures stuff. Growth is subpar, and the Bank of Canada has stopped warning people about rising interest rates. As I told you a few days ago, it’s way more fussed over an inflation rate on its way to zero.
As a result, the central bank will keep its key rate sitting where it is – in the ditch – until 2015. That doesn’t mean long, fixed-rate mortgage rates won’t jump (they will, in late March) because those are set in the bond market. But it does mean VRMs – variable rate mortgages – will be dirt cheap for another two years.
So why would you borrow money at 3.79% at BeeMo or Scotia when the same bank will give you a floating rate of around 2.5%? Why wouldn’t smart homeowners invest the extra money, get a bit of growth, and chunk it against the principal when the loan comes up for renewal?
Because most people think with their duodenums. Bankers and mortgage brokers, with a vested interest in promoting fixed-rate loans (more revenue and commission), have scared the poop out of folks, convincing most they’ll be ‘safe’ if they lock in. As a consequence, given current conditions, these poor sods collectively will be shelling out millions more a year than they have to in interest.
Yes, the rate on a VRM can increase (and will, eventually). That means although your monthly payment remains fixed, more of it would go towards interest and less to paying off the debt with each move higher. But so what? Variable rate mortgages are almost always convertible. That means if you read a pathetic blog written by a bearded god, for example, and learn a rate increase is imminent, you can always convert to a fixed loan with one phone call.
In other words, why aren’t 80% of borrowers saving themselves thousands of dollars a year by riding with a variable rate that’s a full 1% less than the five-year toll, when they have built-in protection from spiking rates? Do they enjoy paying too much? Do they covet TNL@TB?
Nope. Just emotional. Fear’s the great motivator. So most people would rather avoid paying more for their mortgages if rates happen to rise in a few years than pay more now for a few years with a higher rate. (That sentence actually makes sense. Trust me.)
Lesson: go variable. Unless, of course, you are a deflowering virgin and can’t afford it.
Little-known but most real is the Bank of Canada ‘benchmark rate.’ This sucker is struck at 12:01 am ET each Monday, and becomes the official qualifying rate for that week for borrowers who don’t have a 20% down payment.
These are the people who must purchase CMHC mortgage insurance (insuring the lender, not them, against default) in order to secure a loan because they’re high-ratio borrowers. Regardless of the great rate the bank may be offering (like 2.5% for a VRM), if these people choose a mortgage term of less than five years, or any variable mortgage, they must qualify to make payments at the benchmark rate, not the bank’s offered rate.
And what’s the benchmark rate today? A big 5.34%. It last increased (by a fifth of a point) at the end of August, is more than double the current VRM. Yikes.
For example, a buyer qualified for a regular, discounted 5-year mortgage at 3.49% with a maximum purchase price of $300,000 would have to requalify at 5.34% if she wanted to switch to a variable-rate loan (even though the payments would be less). The result? The maximum purchase price would then fall to $250,000.
The intent of this change (made by that crafty little F, Rob Ford’s former best friend) was to throw a new obstacle in the way of first-time buyers, to ensure they could withstand inevitable rate increases. But it didn’t work. They all locked into five-year mortgages to avoid the benchmark rate, which means they pay more than they have to, can’t save, and become more financially vulnerable – which is why they only had 5% down in the first place.
This is called government. Watch it closely. Do the opposite.