Garry Marr
Financial Post

It doesn’t make much sense, but a skimpy down payment on a home might actually get you a better mortgage rate in today’s market.

Blame the government subsidy known as mortgage default insurance, which ultimately makes it less risky to lend money to someone who has only 5% down compared to someone with 20%.

Consumers with less than 20% down must get mortgage default insurance in Canada if they are borrowing from a federally regulated bank. The cost is up to 2.75% of the mortgage amount upfront on a 25-year amortization but that fee comes with 100% backing from the federal government if the insurance is provided by Crown corporation Canada Mortgage and Housing Corp.

“It’s already happening,” says Rob McLister, editor of Canadian Mortgage Trends, who says secondary lenders are now offering rates that are 10 to 15 basis points higher for a closed five-year mortgage for uninsured consumers.

The crackdown on mortgage insurance announced by Jim Flaherty, the federal Finance Minister, could exacerbate the situation. Mr. Flaherty, who mused to the Financial Post editorial board last week about getting CMHC out of the mortgage insurance business, has placed the agency under the authority of the country’s banking regulator, the Office of the Superintendent of Financial Institutions.

Mr. Flaherty also put in new rules on bulk or portfolio insurance. The banks had been paying the insurance premium on low-ratio mortgages — loans with more than 20% down — because it was easier to securitize them.

However, Mr. Flaherty says those loans will no longer be allowed in the government’s covered bond program.

“Long story short, it is going to tick up rates to some degree,” Mr. McLister says. “You are seeing an interesting phenomenon where if you go to get a mortgage today, you are oftentimes quoted a higher rate on a conventional mortgage. Presumably you have less risk because you have more equity.”

It all depends on the lender. For now, the Big Six banks have kept consistent pricing between low-ratio and high-ratio mortgages.

“There is a question on whether they will continue doing that or raise rates overall to compensate for higher conventional mortgage costs,” Mr. McLister says.

Farhaneh Haque, director of mortgage advice and real estate-secured lending at Toronto-Dominion Bank, says competition among the Big Six banks is keeping rates down and stopping any of them from raising rates for conventional mortgages.

“When we can’t securitize a deal, there is a different cost of funds but the bank continues to offer the same rate,” said Ms. Haque, adding her bank did charge a premium for stated income deals, which usually means self-employed people, but removed the difference last week. The premium was 20 basis points.

“Looking at the competitive landscape, it was a disadvantage,” she says. “We were aiming to target pricing that was specific and for the risk appetite for that deal itself. We didn’t want one [deal] compensating for the other.”

But the banks have bigger fish to fry than just your mortgage. Those with the larger equity position in their homes may be a costlier mortgage to fund, but they also could be a future line-of-credit customers. There’s also the potential for other business such as RRSPs and TFSA, so losing a few basis points might make more sense in the long run.

Peter Routledge, an analyst at National Bank Financial, says he wouldn’t want to be an investor in a bank that approached its business any other way, though he did acknowledge there is a cost to keeping those conventional mortgages. “It’s in effect a subsidy,” Mr. Routledge says.

While banks may be eating some of the costs for people who are not eligible for a subsidy, if they continue down that road they might not be able to match the rates some of the secondary lenders are able to offer with insured mortgages.

It doesn’t sound like much, but the difference between, say, 3.14% and 3.29% on a $500,000 mortgage amortized over 25 years would be about $3,500 extra in interest on a five-year term.

It’s true that those people getting the better rate pay a hefty fee up front in insurance premiums, but they also represent a greater risk to the taxpayer. Do they deserve a better rate?

Dr. Sherry S. Cooper
Financial Post

Housing is a key sector in any economy and many developed countries pride themselves on a high level of homeownership. Certainly that is the case in Canada and the U.S., and increasingly the case in emerging economies such as China where homeownership has grown very rapidly. But, as we have painfully seen in recent years, over-investment in housing creates fault lines that result in enormous economic instability and dislocation.

Case in point is Spain, where the housing bubble has caused an economic disaster. For nearly a decade starting in 1999, house prices exploded in Spain as both domestic buyers, and more notably, foreign buyers poured money into residential real estate. Europeans, Russians and others were using the Costa del Sol as their vacation hideaway and condo building in all parts of Spain exploded. The return on investments in residential real estate majorly outpaced the return on any other asset class, so even ordinary Spaniards bought second and third homes expecting to rent and flip them for astonishing gains.

The growth boom in Spain was focused on housing, and households invested a significant portion of their assets in residential real estate. At its peak in 2008, nearly 80% of Spanish household assets were in real estate, well above current levels in the U.S. and Canada. For Canadians, the share (39% in 2011Q4) is close to a record high, at least as far back as 1990 when the data first became available. The Toronto condo boom has raised the spectre of a Spanish-style housing bubble fuelled in large measure by foreign capital and domestic investors — but the numbers so far pale in comparison to what happened in Spain or the U.S.

As the U.S. housing market is bottoming, Spain’s housing collapse likely has much further to go and it is taking the Spanish economy down with it. In Spain, house prices have already fallen 21% from their peak in Q1 2008 and some estimate that they will ultimately be down more than 55% before this is over. This compares to the total decline in U.S. house prices of just under 35%.

Normally, in such a situation, one part of the adjustment process is a devaluation in the domestic currency; but, because of the euro, this adjustment mechanism is not available. Instead, a hugely painful internal devaluation of wages and prices must occur.

The housing bubble in Spain was proportionately 2.5 times bigger than in the U.S. and the decline in the U.S. dollar has helped to offset some of the effect on the U.S. economy as net exports and corporate spending cushioned some of the impact. In Spain, there is no such cushioning, so the economy is in free fall and exacerbating the situation are the draconian fiscal cuts forced on the Spanish government by the stronger countries of Europe. The overall jobless rate has risen to nearly 25% and youth unemployment now exceeds 50%.

In addition, mortgages in Spain, unlike the U.S., are recourse loans so there are no ‘strategic foreclosures’ where homeowners walk away from their homes, but keep the rest of their assets. In Spain, as in Canada, losing your house means losing everything. Even with unemployment at Great Depression levels, homeowners are trying to make their mortgage payments, but many are at risk of losing everything. As well, banks are reluctant to foreclose to avoid further reductions in their already depleted capital. It has been reported that, in some cases, they are reducing monthly payments by converting amortized loans into bullet loans, increasing the risk to the bank.

Most Spanish banks have not fully reported the decline in their asset values. The cost to the government to return their banks to solvency is likely larger than currently recognized. Moreover, Spanish bank exposure to commercial real estate is also relatively high and commercial developers are largely near bankruptcy.

Lessons Learned for Canadians

Too much reliance on housing appreciation for wealth accumulation and retirement security is very dangerous. Retirement nest eggs in Spain have been obliterated, and nest eggs in the U.S. have shrunk considerably. Too much household debt is also very dangerous. It increases vulnerability to interest rate risk and to economic risk of income losses or job losses. Canadians are in much better shape than so many in the rest of the world, but Canadians have taken on far more risk than ever before. As more and more of us depend on RRSPs rather than traditional pensions and will need to rely, as well, on home equity to assure financial security, we are more vulnerable than ever to market swings and economic risk. At a time when more of the population than ever before is running out of runway before retirement, stepped-up saving and significant debt reduction are more important than ever.