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decoding the mortgage market

If you're a first-time home buyer, odds are that you don't have a 20-per-cent down payment. Without one, you typically need mortgage default insurance to buy a home.

The biggest provider of that insurance is government-owned Canada Mortgage and Housing Corp. (CMHC). Since the credit crisis four years ago, its mortgage role has been hotly debated.

On the one hand, CMHC makes mortgages cheaper and more accessible. On the other hand, critics say government-supported housing inflates home prices and puts taxpayers at risk if swarms of borrowers default.

So that begs a question. What if politicians sided with those critics? What if Ottawa forced higher down payments and drastically scaled back its mortgage guarantees? How would Canadian home buyers fare?

Here's a sampling of what you could expect to see:

Tumbling home prices
Demand would drop off a small cliff since 35 to 50 per cent of purchasers are first-time buyers, depending on the year. The Canadian Association of Accredited Mortgage Professionals (CAAMP) estimates that home purchases would plunge by 100,000 annually if minimum down payments rose by even five percentage points. Then again, falling home values would lower purchase prices. A 15-per-cent price drop means the average home buyer would pay $52,500 less for a house. Other things equal, that's a $250 monthly payment savings versus today.

Economic fallout
The economic repercussions are virtually unquantifiable. One-fifth of Canada's economic production can be traced back to housing-related spending. Falling prices and levels of home ownership would slow economic activity. That means fewer jobs (almost one in six new jobs are construction-related), lower wages, more mortgage defaults and a meaningful drop in consumer spending. But over time, the economy would adjust. Switzerland, for example, has roughly 65 per cent renters and it's one of the most prosperous countries in the world. Reduced home buying could also encourage healthier savings rates.

Higher rents
Our ever-growing population needs to live somewhere, whether in a house they own or a rental. In many cities, rental supply is tight with fewer than three out of 100 rental units available for rent. If young Canadians can't buy, they'll add to rental demand and push up rents until supply catches up, assuming it does.

Longer wait times
It takes roughly four to five years for most Canadians to save up even a 5-per-cent down payment. But without mortgage insurance you need 20 per cent down for good rates, or 15 per cent down for non-prime rates. Saving that much could take a dozen years or more if you had no help. People would be waiting until their mid– to late-thirties to buy, assuming they didn't spend their savings beforehand. While renting, they'd also forgo any price appreciation, but save on home ownership costs like property taxes, condo fees, maintenance and so on.

Lower insurance costs
Lower prices and 20-per-cent down payments would save most first-time buyers $5,000 to $10,000 in default insurance premiums, plus interest on those premiums over the life of their mortgage.

Retirement risk
Canadian's single biggest investment is their home. Devaluation and hampered growth of that asset might put hundreds of thousands of seniors in jeopardy, especially if their other assets didn't return enough to fund their cost of living.

Higher mortgage rate
Government-backed financing gives investors the confidence to provide mortgage capital at extremely favourable rates. Without it, virtually no one would lend to you with only 5 per cent down. What's more, federally regulated lenders are required by law to insure high-ratio mortgages. Non-bank lenders might some day offer low-down-payment uninsured financing, but the rates wouldn't be pretty. Uninsured 90 per cent financing could easily cost up to 2.5 percentage points above today's rates. Picture a 5.5-per-cent five-year fixed rate, compared with today's 3 per cent. Over 20 years, a 2.5-point rate premium would cost $29,000 more in interest on a $250,000 mortgage, not including lender fees. But again, lower purchase prices could offset this difference.

Less lender choice
Without insured mortgages, fewer investors would provide small lenders with low-cost funding. It would be much harder to compete with major banks whose cheap deposits and superior credit ratings allow for the best possible funding costs. Less competition means fewer mortgage choices and fewer alternatives to things like high mortgage penalties at the banks.

Restricted lending areas
Most lenders don't like lending in small or rural markets where it's hard to resell a repossessed home. Insured financing from CMHC encourages lenders to take that risk. Without it, more people would have to buy closer to urban areas, harming rural Canada and driving up urban home values.

Some will consider all these factors and feel it's worth the economic side effects to pull back government from housing. They want more affordable home prices and lower risk of an insurer bailout, however remote it may be.

Others take a "don't fix what's not broken" stance, arguing that federal housing policies have:

  • spared Canadian housing from catastrophic weakness during the great recession
  • required borrowers with low down payments to have good credit, reasonable amortizations and sensible debt ratios
  • made borrowers liable if they default and trigger a mortgage insurance claim
  • kept defaults near four-year lows (albeit, this is not a foolproof indicator)
  • required mandatory default insurance, which ensures the government can easily influence underwriting policies at all lenders, something it couldn’t do in a private market.

The above analysis is far from exhaustive but it's safe to say there are risks whether we keep or rebuild our current system. As an individual, such changes could make you better or worse off depending on your discipline, personal goals, net worth and how tied your fortunes are to housing.

For the time being, mandatory 20-per-cent down payments are merely an academic discussion. Our government wouldn't risk such a bold change. That said, the trend of transferring more housing risk to the private sector may continue.

Other countries deem us lucky to have a proven and reliable housing finance system. Rather than dismantle it, it's likely safer to spot the risk areas and carve out those malignancies with a scalpel. That would minimize collateral economic damage, incentivize proper risk taking, and further reduce the odds of government-funded mortgage rescues.

It would also preserve housing options for qualified Canadians who have lesser payments but can afford to own.

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