CMHC Under Fire

For years, while Americans were taking out outrageous loans to buy homes they couldn’t afford with no money down and at ridiculous variable interest rates, Canadians just shook their heads in disbelief, wondering how and if their neighbors would ever be able to dig themselves out of bottomless pits they had so readily jumped in. Canadians even prided themselves at having an actual savings rate and manageable level of personal debt. Yet, instead of waiting to say the proverbial “I told you so,” we’re about to embark on the same path.

Canada Mortgage and Housing Corporation (CMHC) recently came out with incentives for interest-only mortgages, the kind where only interest is due, but principal does not get paid down. There is a reason why the words “mortgage” and “morgue” sound so much alike. When you buy a house with a mortgage, by the end of the amortization period, you often pay for two houses, not one. So, paying only interest and not even a portion of principal is not only a short-term kick, but in many cases the equivalent of a personal financial suicide.

This is why it was so surprising that CMHC, a government agency “sworn” to make housing more affordable, offered to insure interest-only mortgages. What is not surprising is getting reprimanded by the Bank of Canada’s Governor, David Dodge. Simply, supporting interest-only mortgages could be inflationary. Increasing inflation is proportionately related to increasing interest rates. So, higher the interest rates, less affordable the housing!

Now Mr. Dodge wants CMHC to take another look at the analysis behind the decision to insure interest-only mortgages, wave application fees on certain types of mortgages, and offer insurance to amortization periods of up toe 35 years.

In Canada, first-time buyers can get a house with as little as five percent down payment, and there are even zero-down mortgages. By the same token, people in the resale market are required to put down at least ten percent. The usual amortization period has been 25 years.

However, anything below the 25% down payment has to be insured through CMHC, which, in the case of high risk mortgages acts as the second fail-safe. Of course, this insurance is not for the sake of the borrower, but to protect the lender from defaults. This is why insuring an interest-only mortgage seems like going out on a very unnecessary proverbial limb.

For years, the private lending sector in Canada has been coming up with truly creative ways to attract borrowers. But, having CMHC insure interest-only mortgages has given these “alternative mortgages” an official seal of approval, regardless of the inherent risks.

In the U.S., former Fed chairman, Alan Greenspan, called similar alternative mortgages “exotic.” He also pointed out that enticing people to buy homes they cannot afford would result in a bubble, the full scope of which is already materializing in the U.S.

As a defense, Americans can at least use the excuse that it had all started when interest rates were low, as was inflation, which fueled the housing demand. But, that is hardly the case now, even in Canada, where interest rates did not go up as much as south of the border.

On the other side of the spectrum are real estate analysts and CMHC itself that claim the latter’s recent decisions are not going to overheat the market, and that Mr. Dodge and the Bank of Canada are in a much better position to stop it from overheating. All it takes is to raise interest rates.

In my humble opinion, I care little for any decision that might provoke raising interest rates. Last week, the Bank of Canada stayed put, announcing that seven increases of 25-basis points since September last year were sufficient to keep the economy from growing too fast. I’d like it to stay that way for a while. Plus, “endorsing” high-risk debt is a bad idea, whichever way you look at it.