Canadian debt levels are at historic highs and this is largely due to people taking on bigger mortgages.
Mortgages make up 68% of Canadian’s total debt, according to the CMHC's Canadian Housing Observer 2011. That’s a total of $1.042 trillion we owe on our houses. CMHC insurance is required for anyone buying a home with less than 20% down.
CMHC insurance stretched to its limit
As a result, the Canadian Mortgage and Housing Corporation (CMHC) has been insuring more mortgages to satisfy the appetite of Canadians wanting to buy bigger and more expensive homes. With interest rates at historic lows, money is cheap and this makes real estate very attractive.
In addition, banks are moving to take risks of their books and looking for insurance on loans that have higher ratios. It's not required by law, but what it does is it securitizes these loans, gets them off the bank's balance sheet and reduces their capital requirements. Banks are paying the insurance premiums to do this, but its worth it- for them.
The problem is it's putting taxpayers at risk, as more and more loans are backed by the federal government and the increase is reducing the room in the CMHC limit of $600-billion possibly making the insurance unavailable to those who really need it.
For more information on why the CMHC is approaching this limit now, check out my interview with George Hugh, President of Taurus Mortgage Capital.
New homeowners have the most to lose
In a worst-case scenario, if there was a U.S style housing crisis in Canada, taxpayers would be on the hook for 100% of the shortfall of all insured mortgages.
In a softer example, if the limit was reached and CMHC had a reduced amount of power to insure mortgages with less than 20% down, many new homeowners and middle-class families with low ratio mortgages would be unable to fulfill their dream of buying a home. This short-term effect would mean people would have to wait longer to save the hefty down payment needed to avoid CMHC mortgage insurance.
For the medium term, there could also be a pullback in home prices as fewer people would be in the market shopping for a home. Less demand means less reason for home prices to rise. It’s simple economics.
In my opinion, this would be the positive result of CMHC insurance limits being reached. I suspect anyone looking for a home in a big centre like Toronto would agree that $450,000 is not the normal average price of a single-family home.
What can CMHC do?
CMHC could go to parliament and ask for this limit to be raised. The last time that happened was 2008 when the limit was raised $150-billon to where it is right now. On average every 3-5 years as the mortgage market grows, CMHC has asked for, and received, approval from parliament to raise this limit.
But does that mean it should? If Canadians debt levels are the highest in history, mainly due to mortgages, should the government make exceptions for this to continue? As well should banks be allowed to insure loans with high ratios to reduce their own risk? In both cases, I think no. The CMHC was created to help responsible Canadians get into a home with a lower ratio mortgage and they should stay with that ultimate goal.
Canadians continue to live beyond their means
This limit almost being reached is another example that Canadians are living a lifestyle that’s unaffordable. It clearly shows without historic low interest rates and security like mortgage insurance, it would be unattainable to live the way we do. It may seem harsh, but anyone reading my weekly blogs on RATESDOTCA will know that I strongly feel Canadians have become addicted to cheap money and are living a borrowed lifestyle that is unsustainable.
CMHC should not ask for its limits to be raised, it would be irresponsible. What it should do is stop insuring very low ratio mortgages and halt giving banks the freedom to offload risk on higher ratio loans.
Finally, the CMHC limits being reached may be a concern to the banks and economists. But to the average homeowner, it’s a reminder that we cannot rely on the government to help us out with our home purchase and saving for our own future will make us more financially secure.