Regulation Overkill!!!

Sorry folks, this is going to be a long one. A few weeks ago I posted an entry an about some proposed government changes to mortgage insurance regulation and at the time had mixed feelings about it. I think my opinion has changed....significantly!! At the time there was some ambiguity in the changes that have been clarified by the Feds and in my opinion they are definitely detrimental to the Canadian mortgage market.

The initial announcement stated that all borrowers with a loan-to-value ratio greater than 80% taking terms of five years or less, whether variable or fixed would have to qualify at the five-year fixed rate. This would ensure that if borrowers were taking shorter fixed terms or variable terms that in theory if rates go up over the course of the term, they would be able to carry a larger debt-load and there would be less of a payment shock. The ambiguity is that the announcement didn’t say WHAT five-year rate would be used to qualify. After all, there are posted rates, special rates, discounted rates, broker rates...you get the jist. Well, they cleared up the ambiguity by explaining that it’s the chartered banks five-year posted rate (or the contract rate, whichever is greater) that will be used. The chartered banks’ five-year posted rate right now is 5.39%. This is the rate you’ll see on their websites and renewal statements and I’d be very surprised if anybody still pays these rates. The flipside is the discounted rates available in the broker world. I’m not talking specials or quick closes or anything like that, I’m talking about straight-up, five-year, 120-day rate hold rates, which right now are at 3.79%. So, for people taking a 3-year variable at 1.75% (currently) or a 4-year fixed at 3.69%, they need to qualify at 5.39%!! Most people don’t know that prior to this announcement, variable mortgages were qualified at the 3-year fixed rate so there was already some protection built in but the 5-year posted? Can you say EXCESSIVE!?!? Here’s where it gets even more annoying...for anyone taking a 5-year or greater fixed rate, they will be qualified at the contract rate. So they would qualify at the 3.79% mentioned above for five years. That means a borrower looking at a 3-year mortgage which is currently at 3.35% would have to qualify at 5.39% but someone looking at a 5-year fixed would qualify at 3.79%. Ultimately for anyone borrowing at a loan-to-value of greater than 80%, they just had most of their choice taken away. The difference in buying power between qualifying at the contract rate and the posted rate is huge. That means in order to maximize buying power, borrowers are forced to go at least with the five-year fixed. It’s like the high-ratio market has stepped back 25 years where there was hardly any choice available.

Another forthcoming regulation change that managed to slide through that I didn’t mention in my previous post is a change that will affect small business owners. There is a high ratio program available right now that allows small business owners to qualify for mortgages using non-traditional means of proving their income. That means not using T4’s and tax returns to prove their income. Instead, they’ve been able to use an option called stated income to declare what their “real” income is as opposed to what they make on paper. In these cases, the lenders and insurers would assess the reasonableness that a borrower makes what they say they make. Makes sense since one of the goals of small business owners is to minimize their taxes and ultimately the income they make on paper. Since this works in a negative way for mortgage qualification, the above program was set up to help those borrowers. Until now, they’ve been able to borrow up to 95% of the value of the property. As of April 9th 2010, they will only be able to borrow up to 90%. Might not seem like that big of a deal but one of the things common amongst all small business owners is the desire to make your money work as much as possible for you. That additional 5% down payment is money that could be working in other ways for them, like growing their businesses. The other element to this change that has an even greater impact in my opinion is that it used to be that the length of time you were in business was irrelevant, after April 9th, if you’ve been in business for more than 3 years you won’t be able to take advantage of this program. So, anyone in business more than 3 years will have to prove their income or in other words, use what they report as income on their personal tax returns. This change has huge impacts on small business owners who will ultimately have to put more money down on their purchases instead of being able to leverage themselves and use their cash for more productive things.

Now that the changes are more clear, I truly believe they’re excessive. I understand that the Government is doing what they think is best to protect against what happened to the mortgage industry in the US. However, even at our most aggressive point, we were never even close to what the US mortgage system was like. They had 125% mortgages and the 2/28 mortgage. For those of you who don’t know what that is, it’s the product that essentially caused the US turmoil. Where our government is trying to defend against the payment shock of increasing rates, US lenders actually built the shock into the product. It went like this, lenders were selling 30 year mortgages to clients that had a low, teaser rate for the first two years then after two years it would go up by sometimes 4-5% for the remaining 28 years. The craziest part of it was that lenders were qualifying clients at that low, teaser rate and telling them not to worry about the higher rate after two years because “of course” property values will go up in those two years at which point you can refinance and never have to deal with those higher rates. Well guess what happened when property values didn’t go up...people couldn’t afford the higher payments and the sh!t started hitting the fan. The point is our system is so much more conservative than the US system yet the Government seems to think it needs to over-regulate us to protect us from ourselves. The ironic thing is that they think they’re protecting us from a potential housing bubble when there are no signs of there actually being one. Except, with borrowers buying power being reduced, sellers won’t be able to sell their homes at the prices they’d like, ultimately driving the overall market down and creating a mini-bubble.