Finance Minister Jim Flaherty made a statement on December 18, 2009 regarding maximum amortization periods and down payment rates. While I don’t have a copy of the statement or speech made, the National Post has a fairly good summary.
The salient detail is that the finance ministry might change the guidelines and decrease the maximum amortization period of a mortgage (currently 35 years), and increase the minimum downpayment (currently 5%). It would be likely that 30 year mortgages with 10% down payments will be the new rule.
The federal government is probably realizing that the CMHC has guaranteed a ton of debt and in the event of a Canadian real estate meltdown that it would have to pay a very heavy bill as people begin to default on underwater mortgages – this would occur when incomes do not rise to match rising interest rates. Most of the Canadian banks would get away with the financial damage, while CMHC would be paying the bill.
CMHC does collect a one-time insurance premium, according to this schedule:
| Loan-to-Value | Premium on Total Loan | Premium on Increase to Loan Amount for Portability and Refinance | ||
|---|---|---|---|---|
| Standard Premium | Self-Employed without third Party Income Validation | Standard Premium | Self-Employed without third Party Income Validation | |
| Up to and including 65% | 0.50% | 0.80% | 0.50% | 1.50% |
| Up to and including 75% | 0.65% | 1.00% | 2.25% | 2.60% |
| Up to and including 80% | 1.00% | 1.64% | 2.75% | 3.85% |
| Up to and including 85% | 1.75% | 2.90% | 3.50% | 5.50% |
| Up to and including 90% | 2.00% | 4.75% | 4.25% | 7.00% |
| Up to and including 95% | 2.75% | 6.00% | 4.25%* | * |
| 90.01% to 95% — Non-Traditional Down Payment |
2.90% | N/A | * | N/A |
| Extended Amortization Surcharges | ||||
| Greater than 25 years, up to and including 30 years: 0.20% Greater than 30 years, up to and including 35 years: 0.40% |
||||
So let’s pretend you buy some Yaletown condominium for $400,000 and decide to pay 5% down and a 35-year amortization. Your insurance premium, with a verifiable income, is 3.15%, or about $12,000 for the right to have your bank protected in the event of you defaulting on the $380,000 mortgage.
If the rules change to 10% down and 30-year amortization, the CMHC premium goes down to 2.2%, or about $7,900 on a $360,000 mortgage. Strictly looking at the premiums, it would suggest that changing to a 10%/30-year system would reduce defaults by 30%.
The problem deals with correlation – if one mortgage defaults, it is more likely that others will in a cascading line (mainly because CMHC will have to sell the property in order to recover as much of the defaulted loan as possible, depressing the market, and likely causing other strategic defaults). It doesn’t matter what caused the default, but my prime hypothesis is when people go and get their 2% floating rate mortgages, when the Bank of Canada starts to raise rates in the middle of 2010, people will be facing double interest payments when they haven’t properly budgeted for it.
There is also the batch of people that got low 5-year fixed rate mortgages facing renewal – right now 5-year fixed rates are still at relatively low rates (3.8%) but the party will end.
The finance ministry is just trying to make sure the party ends slowly (by people paying off their high-leverage loans over a long period of time), instead of the cops coming in and storming the house (if people can’t pay the interest on their high-leverage loans and cause a cascading default). Jim Flaherty probably knows this is a financial time bomb that can potentially go off if the wrong circumstances hits the economy, and is taking preventative medicine to do so.
CMHC mortgage bonds currently trade like fixed income government securities. You can see a chart of mortgage bonds outstanding on this chart.