Only 18 days until the election, and every party has a terrible housing plan. One of the more interesting ones comes from the Conservative Party of Canada (CPC). The key point is extending the maximum amortization for mortgages. This is a fancy way of saying they want to let buyers pay their mortgage over a longer period of time. The odd thing here is the government before this one spent a lot of time explaining the risks of extended amortizations. That government was led by, *drumroll* the Conservative Party of Canada. Yeah… it’s weird.
As stated in yesterday’s piece on why the Liberal housing plan is a terrible idea, we’re not picking on a party. We’re taking a non-partisan approach, so we’re only looking at the housing plan. We’re also exclusively looking at the risk each plan produces, and who benefits the most. Parties are great at discussing the positives, but they rarely discuss platform issues. Yesterday we covered the Liberal housing plan. Today we’re looking at the CPC housing plan, and tomorrow will be the NDP. Got it? Let’s start.
To Infinity and Beyond – Extending Amortizations
The key point in the CPC housing affordability plan is to extend amortization. For those wondering, amortization is the process of spreading a loan out over time. If elected, first-time buyers will get an extra 5 years on their amortization. That turns the current maximum of 25 years to 30 years. This would lower the monthly payments by about 8-12%. This one is best understood with some quick mortgage math.
Let’s say you’re taking out a $500,000 mortgage, with a 5-year fixed term with a rate of 5%. We’ll circle back on why it’s 5 percent in just a second, but anyway. Using a 25 year amortization, your payment would be ~$2908 per month. If you extend that amortization to 30 years, your payment drops to ~$2,668 per month. By spreading out the payments an extra 5 years, you save your payments are lowered by $240. What witchcraft is this?
Note on interest rates: The rate used is 5%, but you would more likely pay around 3% if you bought today. No one knows for sure where rates are heading, but the bets for lower rates are currently stacking up. Falling rates are bad news. Rates fall when stimulus is needed, and the closer they head to zero – the worse the economy is doing. If rates go negative, we’re in big trouble.
Despite what you heard from your cousin Mike, who flips condos on the side – negative rates suck. Hard. Research shows the only implementations weren’t expansionary to economies. In fact, negative rates often lead to economic contraction. Who cares about the economy, because house prices are going up – right? Well, it turns out bank rates often disconnect from the overnight rate once negative. Researchers found the additional banking risk produced, meant banks began raising rates. This has the opposite effect, actually tightening lending. Darn!
Extending Amortizations Means You’ll Pay More… A Lot More
By extending amortizations, a borrower will pay a lot more in interest. In the 25 year example, you would pay $376,885 in interest, if the effective rate averaged the same over the mortgage. Over 30 years, you would pay $466,279 in interest if all else were the same. That’s ~24% more interest, just to lower your payments by ~8-12%. Most people don’t think too hard about the additional money, but it’s ~$90,000. The difference in interest paid is like paying for a Porsche, and never getting it. Not one mortgage broker I know would suggest this as a way to save money – and the number of brokers I know is oddly high.
Extending amortizations can also lead to higher prices for buyers, limiting any benefit. This is one of those market moves that pulls forward demand, not unlike the Liberal plan. Existing buyers prepared to buy now, would meet with future buyers that move their buy up. The increased competition would mean higher prices in the first-time homebuyer segment. This could mean higher prices, or preventing prices from dropping as much. Making housing more “affordable” by softening downward pressure is… an odd way to tackle the problem.
Canada Has Seen This Before… The Bank of Canada Hated It
During the lead up to the Great Recession, Canada dabbled in extended amortizations. In 2006, Canada loosened regulations in the mortgage industry, looking for financial “innovation.” The Crown owned CMHC kicked things off with government backed 30 year amortizations. This began a mad dash to see who could insure the longest mortgages. Eventually, insured mortgages in Canada extended up to 40 years. To understand this fully, take a sec and calculate how old you’ll be in 40 years. That’s when you will have paid off your 400 sqft condo with combination kitchen-bathroom.
In 2006, the Bank of Canada (BoC) wrote a private letter to the then CMHC governor Karen Kinsley. In the letter, he called the move “unhelpful,” to affordability. In fact, he added they’re likely to “drive up house prices, making them less unaffordable.” He further noted the actions could “have implications for overall financial stability [of the economy].” In theory, the BoC at the time would agree it does the opposite of what we’re promising in 2019 – great.
“Particularly disturbing to me is the rationale you gave that ‘these innovative solutions will allow more Canadians to buy homes and to do so sooner.'”
“I would have thought that as a Crown corporation, you would feel a responsibility to consult with the Bank of Canada and the Department of Finance before taking actions which could make the macro management of the economy more difficult and which have implications for overall financial stability.”–David Dodge, Bank of Canada Governor to the CMHC in 2006.
The Harper Government Didn’t Like Them
Remember Prime Minister Stephen Harper? The rock’n’roll hippie that tried to get Canada out of oil? Well, he led the CPC at the time, and they weren’t too keen on extended amortizations. In 2008, they started to pull back the maximum length of amortizations. At the time, they called the shortening “a responsible and measured approach… to reduce the risk of a U.S.-style housing bubble. It appears extended amortizations isn’t the kind of “innovation” they had in mind.
The reduction helped to limit some of the risk from spreading across the market. If you’re from Toronto, you’re thinking – what bubble? That’s because prices still hadn’t recovered from the 1989 peak, once inflation adjusted. Western Canada wasn’t so lucky. Places like Calgary, did suffer from a significant correction. Shortening amortizations may have helped new buyers from getting in over their heads.
By 2012, the Harper government rolled the maximum amortization right back to 25 years. Finance Minister Jim Flaherty, at the time, said the limit is to ” keep the housing market strong, and help to ensure households do not become overextended.” He further added, “the maximum amortization period since 2008 would save a typical Canadian family with a $350,000 mortgage about $150,000 in borrowing costs over the life of that mortgage.” Rates were a little higher, but even O.G.’s in the CPC were making the same point. By extending amortization, you stand the risk of making housing more expensive. Risk isn’t always terrible, but you also pay more interest, and introduce system risk.
Risking a blow to the whole economy to prop up prices isn’t exactly fiscal prudence, nor does it help affordability. One would argue it does the exact opposite. Funny enough, some of those that have made the argument previously are from the party proposing it.
This is part 2, the Conservative Party of Canada. You can find the risk introduced by the Liberal Party of Canada’s housing plan here.
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First thing I thought of when I heard his housing plan was this isn’t the same Conservative Party of Jim Flaherty.
Which begs the question, if it’s not Harper’s Conservative Party, whose party is it?
Helicopter money… as far as the eyes can see, in every direction. All three parties are vote buying from the industry. Parties are just formalized groups of special interests now, without any concern for what the broader implications are.
People vote for politicians that reflect their ideals. The ideals are broken, as Canada has become largely a debt filled country.
Any time you introduce a credit expansion, you introduce risk.
Extended amortization is something we should be doing at the bottom of the cycle, to help people that are unemployed or unemployed, get a hold of their emergency finances. Disappointed this is even on the table from any party.
70% of our trade comes from the US, and they’re looking at a recession.
https://www.marketwatch.com/story/service-side-of-economy-grows-at-slowest-pace-in-3-years-ism-finds-adding-to-market-gloom-2019-10-03
Correct. This is a big issue, especially in provinces like Ontario that largely depend on cross border business.
Hey blue team, what about ten year loans for new cars assembled in Canada? hahahhahahha….
I need Albas to give his opinion on this plan. It’s odd, to say the least, to go from shouting from the rooftop that tightening of amortizations protects us from risk, to saying it’s how we’re going to promote affordability at the top of the cycle.
All parties entertain risk to promote industry, but this is truly one of the oddest ones possible.
Funny thing about lengthening amortizations. If a first-time buyer in Toronto is still above 35, the banks are more likely to refuse them based on the fact that they can’t pay it off in their working lifetime.
What? How is that possible?
Yeah. The Bank of Ireland had to ask lenders to only allow amortizations past retirement for people trading up. If it’s any higher, there’s too much risk to lend to them.
https://www.irishtimes.com/business/personal-finance/are-you-too-old-for-a-mortgage-or-will-you-just-have-to-pay-up-faster-1.2182533
That’s true… the older age groups really like borrowing. Maybe a restriction on low interest mortgages to age 75, although, most looking to leverage might be forced to reverse mortgage at 5.79%
Punwasi as usual doesn’t say all the truth.
CPC also proposing to remove stress-test for mortgage renewals, which is a big plus for th Housing Plan.
As a member of the CPC, please shut up and stop embarrassing us. You’re making a party known for its fiscal prudence look like we’re a party of people that can’t even read.
The second paragraph.
>> “We’re also exclusively looking at the risk each plan produces, and who benefits the most. Parties are great at discussing the positives, but they rarely discuss platform issues.”
I feel this way about every party. The people with the worst ability to comprehend things, are always the most vocal. Unless it’s your job to look at issues like this, you should probably step back a little or at least be able to spot something in the SECOND PARAGRAPH.
I watched that campain speech of Andrew’s housing plain and he also said they will loosen the stress test.Idiot must be getting advice from his loser freind Tim Hudak
People needs to realize we need to lower residential real estate prices not take on longer mortgages.
How you ask, this is how.
Implement a predatory real estate tax where all non primary residential real estate are charged annually 2-5% of its estimated value. Only licensed corporations are allowed to own residential real estate. All corporations owning residential real estate will be taxed annually at 5%. Do not allow foreign ownership of residential real estate, especially not foreign students.
Jupiter bang on!To many people watching HGTV houses don’t get built in 1/2 hour with commercials.
Oh. But I just bought this starter drill set. What if I give it an hour instead?
Fundamentally all parties are promising to make things worse.
The disconnect between incomes and housing costs is absurd and not remotely sustainable, and adding further stimulus to the bubble markets is insanity.
The hodge-podge of incentives being proposed, which will effectively use public tax dollars to reward speculation, increase inequality, and make housing generally even more unaffordable. How is that even constitutional?
I worked in RE Finance mostly in CMBS internationally for over a decade. the only medicine for canadas problem, is one that will be painful on the short term, but absolutely necessary. simply take out the anomaly in the market; (foreign, often dirty money) then the market will correct, but too many greedy vested interests will allow politicians to do that. this is ridiculously imbalanced. one or two generations will be screwed. the amount of money locked up in RE and not flowing into the general economy is as criminal as most of the offshore mobsters buying RE in Canada. but it will bust some day..good luck canada..do the right thing or face catastrophe.