September 24, 2019 | Really?

Since this election is pivoting on house lust, let’s look at one more key promise: a return to 30-year mortgages.

Those of you who can remember the dark, stormy Harper years will recall Ottawa briefly lost its mind and told CMHC to insure people buying houses with 0% down and mortgages amortized over 40 years. I was a Conservative MP on the House of Commons Finance Committee at the time, and objected enough to cause a Parliamentary hearing into the proposal. Not only did my colleagues eventually vote me down, but this was one more reason the Prime Minister’s Office decided I’d become an enemy of the state.

Predictably, the changes helped create a housing disaster. The government retreated over the next two years as the financial crisis hit. Zero-down was gone, and the max amortization was reduced over time right down to 25 years, to ensure (a) people were borrowing within their means and could repay the loans and (b) the real estate market would go from boil to simmer.

Now the Conservative leader wants to return to long ams, at least for first-time buyers.

What does this mean? Why would it be a good (or bad) idea?

First, the math.

Mortgages are amortized over a long time so people can afford the payments, yet reduce their debt in a meaningful way. Payments are front-end-loaded, meaning in the early years more of each blended payment is interest and in the final years most is principal. (So, because Canadians move every eight years on average lenders make a boodle.) The longer the amortization, the more interest is collected on the loan and the harder it is to retire the debt. But long ams also reduce monthly costs, which is exactly why they are being proposed.

The logic is that lower monthly payments thanks to longer amortizations will render homes more affordable. But, of course, this increases demand and the borrowing potential of buyers. So houses rise in value. Payments may be lower. Debt grows.

Practically speaking, here’s what it means to a typical moister couple borrowing $500,000 to buy a weensy one-bedroom condo in downtown Toronto or Vancouver. The monthly payment (5-year fixed loan, 2.87%) would be $2,333 for a 25-year amortization and $2,068 for one of 30 years.

Nice. Over sixty months  they save a total of $15,900.

But after making $124,114 in payments on the longer-financed mortgage the kids still owe $443,331 five years later. If they had a 25-year mortgage the debt would be reduced to $426,300. So, they pay $15,900 less and end up owing $17,031 more. The ‘savings’ are illusory.

The Conservative leader countered this by saying that young people typically make more money as they progress in their careers, therefore paying less and owing more is just fine with him. That sounds oddly un-conservative, but I get the drift. The trouble is that paying down less of the debt means a reduction in the proceeds when the condo is inevitably sold – and it will be, since nobody can survive more than a few years in a 600-quare-foot concrete box.

In general a 30-year mortgage only makes financial sense when the borrowers take the monthly savings ($265 in this case) and dump them into a TFSA or use the funds  to make an annual prepayment against the principal owning. If it gets spent on vape pens, tats and cellphone bills, not so much.

Meanwhile, mortgage rates are unlikely to stay where they are, despite the popular meme. We’re at the bottom of the rate curve and five years from now – when a 30-year mortgage comes up for renewal – a great deal could change. The time to trash debt is when rates are low. Either do that with a shorter amortization or by savings/investing the difference.

But this is not the main event. That’s housing demand. The more of it, the higher prices rise.

That’s why higher homebuyer plan RRSP withdrawal limits, the shared-equity mortgage, enhanced first-time buyer tax credits, a gutted stress test and longer amortizations are all bad ideas. They fail the task of making houses into affordable homes, just as they delight commissioned realtors and anxious builders.

The higher prices rise and the more indebted our society becomes, the worse the outcome. You’d think people running to be prime minister would care. Really.

Garth Turner September 24th, 2019

Posted In: The Greater Fool

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