Let’s play a wonderful game called: “Who is CMHC, and what do they do?”
When you visit your lender to apply for a mortgage, one of the first questions they will ask is “How much do you have for a down payment?”. If your answer is anything less than 20% of the purchase price, you are legally required by the Canadian government to obtain mortgage default insurance. Why? Because you have less skin in the game and are seen as a bigger risk than Mr. Moneybags who has 50% down – makes sense! And yes, you pay for the insurance which protects the bank in the event that you default on your mortgage.
The Canada Mortgage and Housing Corporation (CMHC) is the largest provider of mortgage default insurance and is run by the government.
BREAKING NEWS FROM CMHC
Making headlines this week was CMHC’s announcement that they are approaching the $600-billion cap set by the federal government (I would guess so considering they were backing nearly $541-billion in mortgages by the end of 2011). The main driver is an unexpected level of requests for portfolio insurance by lenders. CMHC claims that their budget will only affect lenders as it inhibits how much bulk/portfolio insurance they can offer to them. They claim that this will not affect the availability of insurance for qualified home buyers, nor will it affect the cost of buying a house.
Why is this happening? Do more Canadians have high-ratio mortgages or something?
Interestingly enough after browsing through CMHC’s Quarterly Financial Report released June 30, 2011, I found that the average mortgage in CMHC’s portfolio had 45% equity (this is well over the 20% minimum required to avoid insurance) and only 28% of CMHC’s portfolio legally required the insurance.
This means lenders have gone to CMHC themselves and paid to insure the conventional mortgages they have outstanding. Now why would they do such a thing? Why would lenders spend money to insure what is deemed as a low-risk, conventional mortgage?
Simply put: money!
The answer, for dummies:
There is a fancy thing out there called a Mortgage Backed Security (MBS), which are formed through a fancy process called securitizing mortgages; but I’m going to try to describe it to you in layman’s terms and take a few procedural steps out of the process.
Let’s say you’re a lender and you have $1-billion that you have lent out in mortgages. Until more money comes in you’re just sitting on this book collecting principal and interest payments from the mortgage holders; not a bad deal. Not a bad deal at all. In fact, it’s a pretty good deal! Through that fancy securitizing process, you turn your book into an MBS, approach some investors and pitch the idea of investing in the MBS (essentially buying your book of mortgage business).
Your pitch highlights how they will now enjoy the stream of income in the form of mortgage payments from the mortgage holders, and they seem quite interested in that type of return. Then you tell the investors that the risk from the high-ratio mortgages in the bundle has even been dealt with since they are guaranteed by a Crown Corporation called CMHC. So, even if the mortgage holders are unable to make payments and default on their mortgage the investors will still receive their payment! This is a great selling feature, but they still aren’t quite on board. They argue that just because a mortgage is deemed as conventional (20% or more in equity for purchases), doesn’t mean that someone can’t lose their job, for example and default on their mortgage.
You’ve got them on the line… now reel them in!
Ok ok ok, you can see their point. So what are you going to do about it? You’re going to go out and purchase that insurance separately from CMHC and pay for it out of your own pocket to ensure that the ENTIRE portfolio has that CMHC guaranteed stamp of approval on the back. With that stamp, it’s a done deal and a win-win situation. You just freed up some capital by selling off the book and received a premium for arranging the mortgage/being the middleman, while the investors are happy with their risk-free, guaranteed, no-default purchase! Capiche?
Stay tuned for what the experts are predicting will happen next… will CMHC Raise the Roof?
RateSupermarket.ca Week in Review
Bond yields haven’t made any big moves over the past week, contributing to the lack of change in mortgage rates again this week. Interested in hearing what our panel of experts have to say about rates this month? Check out our Mortgage Rate Outlook Panel!
What rates are RateSupermarket.ca visitors searching for this week? Once again, the 5 year fixed closed rates (49.4 per cent) and the 5 year variable closed rates (48.3 per cent). The next leading searches were for 4 year fixed closed rates (0.7 per cent) and 3 year fixed closed (0.4%).