Keep lending predators at bay
Canada should avoid U.S.-style practices, says Frank Clayton
Conversation at kitchen tables across the country these days often turns to the so- called “ housing bubble.” Home prices in your neighbourhood likely have climbed over the last five years and, as a result, you feel wealthier and even happier as you contemplate your next big purchase. A new car, a big- screen television or a great winter holiday could be in your plans.
But, chances are, you also are somewhat concerned that house prices might fall from their current levels, and what that might mean to your financial future. Much of the concern here in Canada about future house prices is being imported from what is happening with our neighbours to the south.
In the United States, many first- time home buyers are struggling to buy houses in high- priced markets. At the same time, there is plenty of mortgage money which, combined with extreme competition among mortgage lenders, is leading to a rapid deterioration in mortgage- lending standards. As a result, growing numbers of home buyers are signing up for risky loans with zero down, optional payments and interest- only features. More and more of these loans are being made by so- called “ predatory” lenders who aggressively target borrowers with low incomes and/ or spotty credit ratings. This results in many consumers paying more than necessary in the form of higher interest rates and fees.
Fortunately, these predatory practices have not taken hold in Canada in a big way, although mortgage money is plentiful here as well. The sub- prime mortgage market is much smaller in Canada, accounting for about 5 per cent of new mortgages versus 22 per cent in the United States. One key reason for this is our current compulsory mortgage insurance system. Compulsory mortgage insurance in Canada for mortgage borrowers wanting to borrow more than 75 per cent of the value of the property ( known as a “ high- ratio mortgage”) from a federally regulated financial institution keeps consumers from being steered into high cost loans.
That’s because mortgage insurance protects lenders against default risk, which in turn allows them to provide low down-payment mortgages at more favourable interest rates than might otherwise be the case.
U. S. federal agencies such as Fannie Mae and Freddie Mac also require mortgage insurance on low down-payment loans, but this requirement is being skirted by mortgage lenders offering sub- prime and other risky mortgage products that result in consumers paying higher interest rates and fees.
Federal policy- makers are now considering whether or not to change our system to an American- style system of mortgage insurance. This could mean higher costs for as many as 60 per cent of Canadian homebuyers who currently use mortgage insurance, including many first-time buyers and people with lower incomes. While costs might drop for some buyers, there is no guarantee. I question whether raising costs for the significant majority is good housing policy. Many Canadian home buyers are taking advantage of mortgage insurance to purchase homes with low down payments at attractive interest rates. Last year for example, the number of highratio mortgages rose by 26.3 per cent versus a gain of less than 10 per cent for conventional mortgages, those with a down payment of at least 25 per cent of the value of the property.
In an example of good public policy that makes a positive difference in the lives of Canadians, mortgage insurance was introduced by the federal government in 1954 through what is now called the Canada Mortgage and Housing Corporation to facilitate access to homeownership, particularly among younger Canadians at a time when lenders often required down payments of 50 per cent or more. With mortgage insurance, people can enter the housing market with a down payment as low as 5 per cent. Mortgage insurance is also available on the same terms to borrowers in all parts of the country, including small communities and rural areas — coincidentally the same kinds of places where sub- prime and predatory lending has increased dramatically in the United States. Compulsory mortgage insurance has given Canadians the best of both worlds: a means of accessing homeownership for households with limited or fluctuating financial resources, and a highly efficient system of housing finance without the competitive excesses that are a worrying feature of the mortgage system in the United States at present.
In addition to rivalling the United States with a virtually identical level of homeownership, Canada has avoided many of their pitfalls and problems. By sticking with our uniquely Canadian system there’s a good chance we can keep it that way. Frank Clayton is president of Clayton Research Associates, a Toronto-based firm of consulting urban and real estate economists.