New homebuyers hit hardest by mortgage changes

The announcement by the Federal Department of Finance to do away with 40-year mortgages and 100% financing has been viewed mainly as a positive for strengthening a relatively safe housing market. Observers do note, however, that requiring homeowners to make a 5% down payment to buy a new home will likely result in fewer first-time homebuyers.

The two major features of yesterday’s announcement were the reduction in the maximum amortization of mortgages from 40 to 35 years and the requirement that homeowners make a 5% down payment in order to be covered by Canada Mortgage and Housing Corporation (CMHC). By law, homebuyers are required to take out CMHC insurance if they make less than a 20% down payment on their new home.

The five-year reduction in amortizations is expected to have a minimal impact — but the 5% minimum down payment could cut into the number of first-time homebuyers in the market, says Pascal Gauthier, an economist who covers the real estate market for TD Bank Financial Group.

“The five-year reduction isn’t that big of an impact. I just read the numbers this morning, and on the average-priced home, we have an affordability measure. Shortening the amortization period gets you about an extra $55 a month on the average price of a Canadian home. That’s not a huge difference,” Gauthier says.

However, Gauthier estimates that about one-third to one-half of new loan originations were coming from high-ratio mortgage financing, in which a homebuyer makes little to no down payment. Anything longer than 25 years is typically an entry point for most first-time homebuyers, who would typically want to refinance into more conventional mortgages down the road, Gauthier says.

“There is no hard data on this. In new originations, it seems to be more than one-third go longer than 25 years. When we start talking about mortgages that range from 25 to 40 years, it’s more often than not very little down or zero down,” he says. “Based on that, I would hazard 100% financings represented a third to half of new originations at their peak, which was arguably last year.”

Mark Olkowski, a mortgage broker and regional manager of Invis for Ontario Southwest region, offers a similar figure for the amount of high-ratio business his team of mortgage brokers has been doing over the past couple of years.

“A large portion of our business has been high-per cent financing over the last 12 months, if not 24 months. It has brought people into the marketplace that could not afford properties in the high-cost housing centres like Vancouver, Calgary and Toronto,” Olkowski says.

Olkowski expects the housing market to take a substantial hit, as more first-time buyers, who tend to inhabit the 25- to 35-year range, are deterred from purchasing a new home. In some cases, the homeowners choose to start paying down a mortgage immediately, instead of saving, in order to take advantage of what has been a period of rapid price increases.

“The first-time homebuyer who buys a home for $180,000 or so will buy another home and they’ll move up, and it really causes a chain reaction in the marketplace. You can count five, 10 or even 20 transactions by just one person coming in,” he says. “One can argue with that one person not coming in, you’re not going to see that chain reaction happen. If the government is trying to slow down the housing market, they have succeeded.”

With interest rates remaining at relatively low historical levels, Olkowski believes the 5% requirement will also take off the table a fair chunk of money that was being redeployed for investment.

“For some of my consultants, it represents between a third and a half of their cases. We are talking about a lot of good clients. Many of those who opted for a 100% financing had the equity to put down but decided not to. They decided to use the remaining money they had and invest it,” he says. “Mortgage rates really have been lower the last little while. They are getting a little higher, but they were able to take that money, put it into an RRSP, invest in the marketplace and do other things rather than put it in the property.”

It is important to note that homeowners are not being required to come up with 5% down payment on their own. The Department of Finance states that they can borrow from another source to make the down payment; however, that portion of the home purchase cannot be insured under the new guarantee framework.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(07/10/08)

Mark Noble