Highlights Of Canadian Mortgage Market Primer From TD Canada Trust

For the doomsdayer's out there, I think we've amased enough proof to show that the downside risks of a significant fall in Toronto's home prices are remote if even possible at all.  It's natural for the media to blow up such concerns (it sells their papers or brings viewers to their newscasts) and it's time that responsible people look at the reality to see what is fact and what is fiction.

To summarize... the chances of major banks incurring massive losses on mortgages in Canada are nil.  The risk of speculators going wild in the market are mitigated by several factors which disuade speculation (bad or dangerous) while not outright discouraging real estate investment (good).  Mortgage insurance protects the banks from borrower defaults and mortgage lending guidelines prevent Canadian banks from encountering the same type of losses as the US banks have incurred.

Below are some of the exerpts from the TD Canada Trust report entitled "Canada Mortgage Market Primer".

Fully 68% of Canadian households own their homes, a level that is roughly in line with the U.S. and U.K. The U.S. is well known for its policy measures to promote home ownership, but Canada has a similar if less appreciated set of public policies to improve home affordability and the availability of mortgages.

Just over half of homes are mortgage-free. For homeowners with mortgages, the average equity is slightly over half of the value of the home. No more than 1% of Canadian mortgage holders have negative equity in their home, and 4% have equity wealth of less than 5% of the home’s value.

Canada’s sub-prime mortgage market never grew particularly large during the boom years – peaking at less than 5% of total originations, versus almost triple this in the U.S. – and most of the Canadian sub-prime mortgages managed to avoid some of the more damaging practices such as NINJA loans (no income, no job or assets) or teaser interest rates. Subsequent regulatory tightening has further diminished the size of the Canadian sub-prime market.

The fraction of Canadian mortgages in arrears by three or more months rested at 0.44% in March 2010, amounting to just under 18,000 mortgages. This contrasts to a cyclical low of 0.24% pre-crunch. The current level is just slightly above the 0.42% average from 1990-2009. By contrast, the fraction of prime U.S. mortgages delinquent three or more months was 7.01% as at Q4 2009.

Given a mortgage delinquency rate of 0.44% and the assumption of a (pessimistic) recovery rate of 80%, this means that expected mortgage portfolio losses for Canadian lenders are less than 10 basis points per year for uninsured mortgages. This is a manageable sum, and easily absorbed by the differential cost between bank funding and bank lending rates.

For real estate transactions, a pre-existing home transaction generally encounters realtor fees in the 4-6% range (this is paid by the seller and split between the buying and selling real estate agents). There are also land transfer taxes of about 1-2% (paid by the buyer to the province) in all provinces except for Alberta, Saskatchewan, and parts of Nova Scotia. The City of Toronto imposes an additional municipal land transfer tax of roughly the same amount.

The aforementioned transactional taxes are sufficiently onerous that flipping homes can be a costly exercise in all but the hottest of housing markets.  An April 19, 2010 CMHC rule change requires that home buyers who do not live in the residence must make a minimum 20% downpayment, versus the usual 5%. This, along with the taxation of capital gains on non primary properties, helps to keep speculation in check.

The traditional Canadian amortization period for a residential mortgage is 25 years. Rules permit an amortization period of as long as 35 years, reduced by the Department of Finance from 40 years in mid-2008. Among newly purchased homes, slightly over half have a 25-year or shorter amortization period. As with the trend towards a diminished downpayment, the general pattern has been towards a longer amortization period in recent years.

By far the most common mortgage term in Canada is five years, though this can range from as little as six months to as long as ten years.

Traditionally, the 5-year fixed rate mortgage has been the dominant mortgage in Canada. In recent years, however, floating rate mortgages have become more popular due to a falling interest rate environment (structurally since the early 1990s, and cyclically since 2007), and based on the calculation that they are cheaper on average across a full economic cycle. This trend may be starting to diminish as borrowers recognize that central bank rates will eventually begin to rise.

At present, fixed rate mortgages constitute a big (though diminished) 68% of the outstanding mortgage stock. 27% are floating rate mortgages, and 6% are some combination of the two. The flow of new mortgages in recent years has been more balanced between the two major categories.

A regular criticism of CMHC over the years is that the insurance program has been designed in such a manner that it effectively provides insurance on the lowest quality mortgages in Canada, with far less exposure to higher quality mortgages. In turn, in the event of a hypothetical sharp housing market correction, CMHC would be exposed to significant losses.

This is undeniable, despite the fact that a U.S.-sized correction is much less likely in Canada due to the predominance of recourse mortgages, stricter mortgage laws, and a variety of other beneficial traits detailed in this report.

Even still, the systemic risks are not especially great for several reasons. By virtue of the mandatory insurance on low downpayment mortgages, the greatest risk lies with CMHC, not the lender. A hypothetical correction would have to be more than twice as large as anything in the past two decades to knock CMHC’s insurance business from its profitable perch, and even then it would have a substantial capital buffer. The latest (2009) annual actuarial evaluation of CMHC’s insurance activity found that it should remain solvent over the long-term. OSFI sets out specific capital reserve requirements and unearned premium reserves, and CMHC currently has double the minimum capital required in its insurance retained earnings.

Read more about...

Mortgage payments
Qualifying for a mortgage
Credit scoring
Pre-Payment options
Other flexible mortgage terms
CMHC Mortgage insurance and the fee structure

by downloading this PDF file.