Canada's Own "Subprime" Borrowing Slapped In The Face

I don't have much time to blog but I'd like to just quickly put up a post regarding today's news. This might be redundant, as most of you have already heard (in the MSM or on other blogs), the federal government is tightening mortgage lending practices. A slap on the face, if you will. Not extreme but it is certainly a step in the right direction.

According to the Finance Department announcement, the following changes will be made to the rules of government guaranteed mortgages:

• Fixing the maximum amortization period for new government-backed mortgages to 35 years;
  
  
• Requiring a minimum down payment of 5% for new government-backed mortgages;
  
  
• 45% maximum TDS ratio (Total debt service ratio - % of gross annual income required to cover payments associated with housing and all other debts and obligations, such as car loans and credit cards)
  
  
• Establishing a consistent 620 minimum credit score requirement; and
  
  
• Introducing new loan documentation standards.

All changes become effective on October 15, 2008 and affect all mortgage lending institutions.

I'm afraid that it's too little, too late. About 62% of first time home buyers choose the 40 year mortgage route as affordability has been stripped in the past years during the real estate bubble. Is this the government's own indirect admission that 40 year mortgages are kin of the famous subprime mortgage? No more liar loans with no downpayment, no authentic documentation and relaxed lending. This will certainly put further downward pressure on prices. In addition, the pool of buyers just shrunk dramatically. The implications of this announcement will be widespread. The government should have done away with the 35 year mortgages as well. The market will always correct itself. Those who forced affordability and bought in the last two years will have a nasty financial ending.

Now, the pressure will be squarely on the sellers. Those now wanting to get out because of the new changes will have to take a financial loss. Remember we are still at record inventory levels. To sell in this marketplace would mean to lower expectations and prices dramatically. On the already over-saturated condo front in Calgary, watch for more intensive promotions (free cars, free gym passes, free trips, first born children, free home entertainment systems, free kitchen makeovers, etc.).

Now I wonder if Ed Jensen will recant his statement in Creb's June report that the market will pick up in activity in the Fall?

I'm expecting realtors (some who are struggling) across Canada to further increase their advertising/marketing budgets from now till October 15, 2008. With sales down 30%-40% yoy already, what will most of them do after that date?

I can already envision the new emergency marketing slogan:
"The best time to buy is now - before October 15, 2008."

False Sense Of Affordability

This might be old elementary news, but over the last couple of years during the inflation of the Calgary real estate bubble many home buyers were "tricked" (yes, I dare say it) into affordability.

A conventional and financially rational mortgage would follow a 25 year amortization period. A down payment requirement of 25% would be a solid foundation. In addition, a single income stream would the norm.

Since February 2006, CHMC has introduced 30, 35 and 40 year mortgages to allow prospective buyers a chance into the real estate market. In conjunction to low interest rates, a well oiled real estate marketing machine, and a booming economy this created the present bubble dynamic.

Recently, the essence of 40 year mortgages has been questioned.

"Canadians are flocking to 40-year mortgages, often without a down payment, and the rapidly developing trend is beginning to ring alarm bells for policy makers in Ottawa.

Both the Finance Minister and the Governor of the Bank of Canada are expressing concern about the situation, as the U.S. economy continues to reel from a crisis triggered by mortgage holders who were in over their heads."

The shocking statistic found in the article is that around 40% of new mortgages are of longer than conventional 25 year periods. Furthermore, 15%-20% of first time home buyers are opting for no down payments and 40 year mortgages. Since Calgary lead the sudden incline in prices, unconventional lending practices may be more pronounced in the market.

Instant applications to a life of serfdom and financial tight rope walking. Longer term mortgages cost thousands more just in paying interest and last much longer. They are only beneficial to your bank, mortgage broker and anyone in the real estate "money supply chain."

"The bigger question is what happens as you go off two, three, four, five years from now, and it's no longer just a significant share of the new applications, but it's a significant share of the outstanding market," said Derek Holt, an economist at Bank of Nova Scotia. "I think we'll be in uncharted waters as to the sensitivity to shocks that most households will find themselves facing." If there is a shock in jobs, interest rates or commodity prices, "unless you see the arrival of 60-year mortgages, then you've got a household sector that's really backed itself up against the wall."

If the current state of affordability is defined as minimal down payment on a mortgage longer than 25 years, the cold reality is much different. You can't afford the house (wait for the price correction).

The most dangerous lifetime financial decision is "force feeding" affordability in a bubble real estate market.