November 22, 2019

Rates you can take to the bank

Garry Marr Dec 3, 2011 – 9:00 AM ET | Last Updated: Dec 2, 2011 10:07 AM ET

Are Canadian homeowners really that much of a safer bet than the Italian government?

It’s an interesting question given that Canadians can lock into a five-year mortgage at a rate just above 3%. There’s more than one European government that would like to borrow at that rate.

The reason Canadians can get such cheap money on a mortgage with as little as 5% down is mortgage default insurance, which is backed by the federal government for both Crown corporation Canada Mortgage and Housing Corp. and its private competitors.

Canadians pay steeply for that mortgage insurance with premiums that can amount to 2.75% on the purchase price of their home. But in the end you have to wonder whether that government backing reduces premiums and amounts to a subsidy for Canadians buying with high-ratio mortgages.

Given all that, it’s no wonder so many Canadians want to jump into the housing market — it’s the only way to get access to that much cheap debt financing. You can almost argue by not buying into the housing market you have missed out on a government program that thousands of Canadians have cashed in on.

“My perspective is it’s good value for Canadian consumers,” said one bank analyst who did not want to be identified. It’s even better value for Canadian banks because their loans are guaranteed by the federal government.

The rules in Canada are such that if you are buying a home with less than a 20% down payment and are borrowing from a financial institution covered under the Bank Act you must get mortgage default insurance.

“Potentially it leaves Canadian taxpayers on the hook for a big bill if things go terribly wrong although I don’t think there any indication things will go terribly wrong,” said the analyst. “There is a good argument that Canadian bank shareholders are being subsidized too.”

Finn Poschmann, vice-president of research with the C.D. Howe Institute, says in a world without government backing some people with high credit scores might end up paying even lower mortgage default insurance premiums.

“In an unregulated world where you don’t require insurance, your lenders would probably ask for it anyway. Your premium might be higher or it might be lower,” says Mr. Poschmann. “You would have market level, personalized risk adjustment on the premium.”

A disadvantage of insurance is you pay the fee up front, meaning if you sell your home you get nothing for that payout. Mortgage insurance is portable now to a degree so if you sell and buy another home, the disadvantage is limited.

The other question that hangs over the issue of default insurance is whether the mere existence of it has helped goose home prices in Canada. Given the average price of a home has more than doubled over the last 10 years, anybody who didn’t get involved in this leverage based investment has missed out on a major financial opportunity.

Author Garth Turner says mortgage insurance has removed the risk for lenders and given borrowers a status they would not get for any other investment.

“It’s a status far above what their real risk level would be,” says Mr. Turner. “If you are lender wanting 5% mortgage or 10% down payment you are high-risk high ratio client and normally under any credit rating system in the world the higher the risk the higher return any lender would demand.”

Nobody would give somebody with $50,000 in cash, $500,000 worth of stock but they give you that much if you are putting the money into a house. And once you’ve got that money, if your home is appreciating in value the way it has the last decade it almost seems like a slam dunk investment given how cheaply you can borrow.

“Some kid wandering into the bank who is 25 years old with 5% down buying a $500,000 condo is able to get the same rate as someone putting 80% down on a house in Rosedale,” says Mr. Turner, referring Toronto’s luxury home market. “CMHC has erased the traditional risk.”

Given all that, how can you pass on leverage investment that offers you cash at rate you could otherwise never get?

Mr. Turner, who continues to predict a pullback in the housing market, points out that with any leverage comes with increased risk — including housing.

“If you are borrowing 95% of the value of your condominium and the real estate market goes down 8%, you are screwed and that can happen extremely easily and in matter of weeks,” says Mr. Turner.

In that scenario, you’re low rate won’t mean too much. If you default, that mortgage insurance is going to come in handy — just not for the federal government.

Comments

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  2. Excellent read I recently passed this onto a colleague who had previously been performing a little research on that And he actually bought me lunch

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