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House prices lead to longer repayments
Does anybody remember the days of mortgage burning parties? Couples would spend 25 years dutifully paying down a loan, then emerge with a debt-free home and invite all the neighborurs over to celebrate the joyous event with a emonial torching of their mortgage contract.
"A mortgage burning p[arty. At some point people did that. It sound like a myth now," laugh Vince Geatano, vice-president of Monster Mortgage. "These days nobody's too worried about paying down their mortgage right away."
In just six months, a seismic shift in thinking has developed among Canadian homeowners, as bank and mortgage insurance companies convince more and more customers to take on mortgages with 40- year amortization periods, up from an earlier
norm of 25 years. This new mindset has largely been driven by mortgage insurance companies' suddently finding themselves in a highly competitive market of insuring what amounted to $80-billion of new mortgages in 2005.
There are $650 billion in outstanding mortgages in Canada. Canada is the second-largest mortgage insurance market in the world, a fact driven largely by rules governing banks that require consumers to buy insurance. Any institution covered under the Bank Act cannot take on mortgage with less than 25per cent down payment unless it is insured.
Also, house prices across the country have gone up more than 10 per cent a year for four straight years, making affordability a creeping problem for prospective homeowners and a longer amortization a necessity. An average home in Vancouver, the most expensive market in the country, sold for $527,524 last moth compared with $312,828 in January 2003.
A consumer putting just five per cent down on that $527,524 home would be saddled with a $3,387 monthly mortgage payment based on 25-year amortization and prevailing mortgage rates for a five-year term. Extending the amortization period to 40 years would lower the monthly mortgage payment by 13 per cent, or about $450 while increasing the total interest to be paid by 76.5 per cent to almost $1-million.
And while consumers may be warming up to mortgages that have a good chance of being inherited by their kids, real estate author Don Campbell said it's the only way consumers can afford their homes today. The logic behind the longer amortization loan is compelling. A $300,000 house-about the average price of a home sold across Canada in the third quarter of this year-with a $270,000 mortgage and a 25 year amortization would have monthly mortgage payments of $1,824.93 based on a 6.6 per cent interest rate.
The same mortgage amortized over 40 years at 6.6 per cent, the current posted rate on five year closed mortgage, would cost the borrower $1,582.86 on monthly basis. The longer frees up $242.07 in monthly cash flow, which can either buy more houses, or more stuff. But the price for that increased amortization is steep. Over the course of the 40-year amortization, the total interest would be $489,742 for what amount to $212,278 more in interest payments than the same loan spread over 25 years.
"I'm not a big fan of the longer amortization because your interest costs are going to be that much more over time," says Gaetano. "People are not discipline enough to increase their payments." Competition among lenders and insurers is making it easier to take on more debt. For years, the insurance industry has been dominated by Canada Mortgage and Housing Corp., the Crown cooperation that counts mortgage insurance among its many duties, which also include social housing. What little competition CMHG has had is due to upstart Genworth Financial Corp., a company created by GE Capital, which has forced the Crown Corporation into a number of innovations in the 11 years Genworh has been in business. For instance, CMHC for years wasn't too interested in insuring self-employed Canadians, forcing them to borrow from obscure lenders and pay exorbitant interest rates.
The two were like Coke and Pepsi with CMHC controlling 70 per cent of the marketplace and nobody else making their way in Not anymore Financial services giant American International Group Inc. set up shop in Canada this past week under AIG United Guaranty. Two other large U.S. companies, PMI Mortgage Insurance and Triad Guaranty Inc. expect to be in business next year.
Many experts in the mortgage industry say it's just a matter of time until consumer are signing on to mortgages based on a 50-years amortization period with the general prediction it will appear in 2007.
The thinking among some handing out the loans is that as consumers wages go up, they'll make payments above and beyond what they are required to -shorting the time it takes to pay down the original loans. Peter Vukanovich, chief executive of Genwoth, said consumers are the ones demanding the longer amortization. He is actually surprised that 20 per cent of his new business is going for an amortization period longer than 25 years.
"We are encouraging people to pay off their mortgage before 40 years. This is just offering them more payment flexibility," he says, adding he expects consumers will do just that.
Don Lawby, chief executive of Century 21 Canada Ltd. calls the new loans heritage mortgages. He says the idea of dying with debt on your home is more common in other jurisdictions. It's not really the end of the world because if house prices continue to accelerate it will leave plenty of inheritance says Lawby. Atypical bungalow in Vancouver might sell for $750,000 today. "Inflation will allow these people to build equity in their homes," said Lawby.
Garry Marr
(November 14, 2006)
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