Over the past couple of years, there has been a great deal of discussion and policy change aimed at protecting us from ourselves when it comes to debt.
There is one obvious idea that would meaningfully do the trick, but we seem afraid to implement it.
That would be to raise down payment minimums on a home from 5 per cent to 10 per cent.
From a taxpayer's perspective, the big risk is the government-backed Canada Mortgage and Housing Corporation (CMHC). Many people think that banks would be at risk, but the first line of defence would be CMHC.
Today, if you are buying a home and you put in a down payment of less than 20 per cent, you will have to pay CMHC insurance. This insurance helps to pay for CMHC, and takes the risk off the lender (bank or mortgage company) in case of default. The default risk on this mortgage is held by CMHC.
In fact, this is one of the risk problems. Most banks would rather offer a mortgage with only 5 per cent down payment than 25 per cent down payment. The reason is that the bank in insured for the 5-per-cent down payment mortgage, but not for the 25 per cent down payment mortgage. This is just one of the ways that we encourage those who can least afford it to take on home ownership.
As a result, the key risk for taxpayers is that those with only 5 per cent to 20 per cent down payment might default on their mortgages. If this group bought houses, and the average price went down 10 per cent, then this group will now have negative equity in their homes. As we have seen frequently in the United States, when there is negative equity in homes, the losses pile up for the homeowner and the lender alike.
Rather than worrying about moving amortization rates from 35 years to 30 years, or only allowing refinancing to 85-per-cent debt levels, let's get to the heart of the matter.
If the minimum down payment backed by CMHC is raised to 10 per cent, then home prices would have to drop more than 10 per cent before people faced negative equity. The total number of these high-debt mortgages would decline, and the entire market would have a much greater cushion.
When you think about it, why should someone who can only afford 5 per cent of a house be supported by the taxpayer in their home purchase? A large percentage of these home buyers are not yet in a financial position to become a home owner. Why should we encourage and support people taking on debt levels many times greater than their annual income?
There are only three answers I can think of for not making this change:
1) The notion of encouraging first-time home buyers is seen as noble, positive and patriotic. It encourages the Canadian Dream.
2) The economic fallout from losing a portion of first-time home buyers would be significant. Mortgage brokers, real estate agents, real estate lawyers, contractors, banks, home reno stores and builders would all suffer financially.
3) If some of the housing demand disappears from the first-time home buyer, all real estate prices could face some downside - at least temporarily.
My view is we should take our medicine now so we don't all get sick.
There is no question that there will be some short-term pain if the 5-per-cent equity limit is moved up to 10 per cent, but think about what it would do to shore up the real risks that we all face in Canada.
A significant number of home buyers who are on the borderline of being able to afford a house might be saved from a financial disaster.
The CMHC would be put in a significantly lower risk position than it is in today. All we have to do is look at Fannie Mae and Freddie Mac in the United States to see what could happen if CMHC is left holding thousands of properties valued below their debt level.
We would significantly lower the risk of having many homeowners desperate to sell homes, and creating a plummeting housing market. This change would provide greater long-term stability for all home owners.
It is about time that Jim Flaherty makes the one tough decision on mortgages that will put Canada on a much stronger financial footing to withstand higher interest rates and declining housing prices.
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