Guess Who’s Counting the Mortgage and Real Estate “Beans?”

Wednesday, August 16th, 2006
By Inya Ivkovic, MA for Profit Confidential

After introducing 35-year amortization periods and interest-only mortgages, Canadian lenders and real estate agents alike are in high spirits. Hardly a surprise, considering that now more Canadians can get into more debt and for a decade longer.

For PROFIT CONFIDENTIAL readers out there, here are a few Red Herrings that we feel obliged to mention–yet again. Firstly, if you opt for an interest-only mortgage, be prepared to pay thousands of dollars more in interest, in addition to what is surely going to be huge mortgage insurance premiums. For our American readers, note that Canada Mortgage and Housing Corporation insures lenders (not borrowers) in case of high risk mortgages, which are those with a down payment of less than 25%.

With more unfavorable debt on your books, there is strong likelihood that you will also lose your financial flexibility. People that have committed themselves to making interest-only mortgage payments, that could last as long as their retirement, are often considered high risk debtors.

On the other hand, banks will keep making loads of money on interest charges, while real estate agents will keep collecting huge sale commission fees because housing may appear more affordable.

On the surface, interest-only mortgages and prolonged amortization periods appear to make housing more affordable. But, this is really a choice between a rock and a hard place. In Canada’s major cities, real estate prices have gone through the roof. This is particularly true for Calgary, where prices jumped almost 50% in 2005, while in Vancouver, real estate prices rose on average 20%. No wonder that, at times, for average two-income families, owning a home appears elusive.

However, with a 35-year amortization period, homebuyers’ monthly payments are much less than for borrowers who opted for a 25-year period. Plus, if they also have interest-only mortgages, these monthly payments get even smaller, since first payments on principal may not be due for the first five or ten years.

This is just how it looks on the surface, and short-term. If we dig deeper, we will see that with interest-only mortgages and with 35- year amortization periods, banks are avoiding or delaying something called the “runoff.”

A runoff is the repayment of a mortgage’s principal amount, either in normal monthly payments, lump sum payments, or full mortgage discharges. Banks don’t like runoffs because the sooner the principal is paid, the lesser amount of interest is collected.

According to Statistics Canada, banks “lose” between ten and 12% in new mortgage business because of runoffs. However, that percentage is likely to decrease significantly with extended amortization periods, such as the new 35-year period.

I don’t know about you, but I hate paying even just a cent in extra interest charges if I don’t have to. The only good thing about new products hitting the market is having more choices. Just don’t forget that new choices are not always and not necessarily there for your benefit. In the case of new mortgage options made available to Canadians as of late, the only ones sure to profit are banks and real estate agents.

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