Growing the pool of risky debt

Monday, July 31st, 2006

Feds are making it easier to get interest-only mortgages

Ray Turchansky

Canada Mortgage and Housing Corp. recently announced moves that critics say will drive many homebuyers to the poor house, as it were, and could leave Canadian taxpayers on the hook.

CMHC is offering mortgage insurance for interest-only loans and on amortizations of up to 35 years, while also scrapping the typical $165 application fee on high-ratio loan products for people with a down payment of less than 25 per cent.

With an interest-only loan, a borrower can pay interest only for the first 10 years, then pay both interest and principal.

Payments are initially low, but since the loan must still be paid off within the original amortization period, payments balloon as the principal starts being paid down, even more if interest rates rise.

The first issue is whether a government agency like CMHC should be competing with private companies in the business of offering mortgage insurance on interest-only loans. If CMHC has to pay out a rash of defaults, the money will come out of Canadian taxpayers’ pockets.

The argument has also been made that mortgage insurance protects the moneylender, not the homeowner.

A recent report by CIBC World Markets noted that outstanding residential mortgages rose by 10.9 per cent during the year ending this past April, adding that “the current wave of growth in mortgage outstanding is of a higher risk,” and that the moves by CMHC imply that “we will see increased default risk in the mortgage market.”

The second issue is the wisdom of making mortgages easier to get for Canadians who are already in a massive hole of debt, with a savings rate that has fallen from 16 per cent in 1985 to negative 0.5 per cent in 2005, meaning they are now spending more money than their current disposable income.

But a survey released this month by BMO Financial Group showed that while 80 per cent of baby boomers own homes and 19 per cent have a second house, only 30 per cent intend to sell their assets to fund retirement.

If a person spends 10 years paying down only interest, he or she saves nothing if the value of the house doesn’t appreciate during that period.

In fact, many people are now buying at the top of a housing boom, particularly in Western Canada, and face the likelihood of selling after the market has cooled off.

Said the Edmonton firm Hendrickson Financial in a recent commentary: “When home prices begin declining, homeowners who have recently purchased with 100-per-cent financing will have to come to terms with owing more than their home is worth.”

That’s when you get people walking away from their homes — when they have no equity to lose and can start all over with a cheaper house that will require smaller payments.

Ottawa bankruptcy lawyer Stanley Kershman, author of Put Your Debt on a Diet, said he’s seeing people declare bankruptcy for the second, third, fourth and fifth time, and cites a judge who over the years has had a father, son and now a grandson appear before him facing bankruptcy.

“They’re getting in too deeply, with too much debt, and as people go to either renew their mortgages or consolidate mortgages, they’re going to end up paying higher and higher interest rates,” said Kershman.

As happened in the early 1970s and late 1980s, people will walk away from their homes.

© The Vancouver Province 2006


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