Buying a home today is more expensive than ever. In economic hubs like Vancouver and Toronto, prices continue to climb into the stratosphere. You can expect to spend on average a whopping 87 per cent of your median household income on housing in Vancouver, while you’ll spend 62 per cent in Toronto. It’s no wonder first-time homebuyers are struggling to get started in the housing market!
No Such Thing As A Starter Home?
The housing market is quickly getting out of reach for our youngest adult generation. With bleak job prospects and an average of $26,000 of student debt, it can be tough to save even the minimum five per cent down payment. Brian Bell, a real estate broker and former mortgage default insurance executive, believes first-time homebuyers need a break. He has started a petition urging CMHC to lower its insurance premiums by 15 per cent for first-time homebuyers.
The Affordability Struggle
In Toronto the average selling price of homes reached a staggering $539,058 in October 2013. If you were to buy a house for that much, not only will you need to scrape together $26,953 (five per cent) for a down payment, you’d also need to come up with up to four per cent ($21,562) to coverage your closing costs. That means you’ll need $48,515 just to purchase a home – and that’s before mortgage insurance has been added to the equation!
Since you’re making less than a 20 per cent down payment, you’re required to purchase mortgage insurance. Unlike closing costs, you won’t have to pay your mortgage insurance premiums all at once. Instead your mortgage insurance is rolled into your mortgage. In the above example, you’ll need a total mortgage of $526,188 ($512,105 to cover your 95 per cent loan to value ratio and $14,083 in mortgage insurance). Although mortgage insurance benefits first-time homebuyers by allowing them to qualify for mortgages with primary lenders at decent mortgage rates, you’ll pay hundreds in interest over the life of your mortgage due to mortgage insurance.
The CMHC’s Profit Margins
It’s harder than ever for first-time homebuyers to qualify for mortgages. The most dramatic change came in the recent mortgage tightening rules in June 2013 that saw mortgage amortization further reduced from 30 years to 25 years for CMHC-insured mortgages. Although these mortgage rules were meant to cool an overheated housing market, the CMHC benefited. The crown corporation averaged $1.1 billion in net income over the past five years and is expected to earn $1.3 billion in 2013.
Premiums Should Reflect Declining Homebuyer Risk
One of the fundamental rules of investing is the risk-return tradeoff. With the stricter qualification rules for homebuyers, the risk of mortgage default has dropped dramatically. The average credit score for homeowners with CMHC insurance was 738 last year, well above the 620 minimum. With a lower underwriting risk for mortgage insurers like CMHC, shouldn’t the premiums be lowered to reflect that? First-time homebuyers already receive a break on land-transfer tax, so why can’t they receive a break on CMHC insurance?
The Potential For Savings
If a 15 per cent discount was applied across the board to all premiums, it would cost the CMHC an estimated $194 million this year, according to Bell. If first-time homebuyers were only given a break, the cost of this premium reduction would be an estimated $92 million. As Bell mentions, it’s important to note that CMHC would not bear the entire cost of the premium reduction since the credit quality of their portfolio will improve as a result of the new mortgage guidelines imposed by the Department of Finance.
Could Lower Premiums Lead to a Re-Heating of the Housing Market?
As this point, you may be asking – didn’t Flaherty impose last summer’s mortgage rules to help lower the average cost of housing in Canada? Wouldn’t making mortgages cheaper further fuel demand and prices? Bell doesn’t believe so, as CMHC insurance premiums are not included in the qualification process. With the same strict qualification requirements still in effect, the same number of homebuyers will qualify for mortgages;the only difference is they’ll receive a 15 per cent break on their CMHC insurance and save hundreds in interest over the life of their mortgage. A 15 per cent cut in CMHC insurance premiums would reduce the average first time buyers mortgage by $1,700, according to Bell.
The changes shouldn’t have a dramatic effect on the housing market, although it will help first-time homebuyers long-term by allowing them to pay off their mortgage years sooner and save hundreds in interest.