3 Aug 2015
From Housing Bubble to Rising Rates, is a Mortgage Horror Movie Waiting To Happen?
We’re all familiar with that part of the horror movie when it seems like an excellent idea to the characters that they split up to cover more ground. I’m sure you’ve been there and uttered the phrase “Don’t go in there”, out loud, to people on a TV screen that can’t possibly hear you. For many current and prospective home buyers, the flurry of news articles regarding ‘Housing Crashes’, ‘Soft/Hard Landings’ and overall doom and gloom, can make those considering a mortgage feel like they’re walking alone, down the stairs into that dark, foreboding basement. Well, let me turn the lights on for you.
Years ago, shortly after the subprime crisis in the US, I read an article in a Canadian magazine that showed the picture of a cartoon house with saw cutting the bottom out from under it. The premise was that the bottom was about to fall out of the housing market and the rationale was predicated on the idea that it happened in the US so it can happen here. That was 7 years ago and reasoning behind the article was at best, misplaced. To understand better why the housing crisis in the US does not immediately mean a housing crisis in Canada, one must understand the basic and fundamental differences between the two markets when it comes to mortgages.
In Canada, unlike the US, mortgages have recourse. This means that if you do not pay your mortgage and the bank ends up foreclosing and selling the property, you can be held liable for any shortfall they incur. In the US, there is no recourse and homeowners can simply walk away from their homes with no worries about being pursued for a deficiency balance. Then there is the subject of interest tax deduction. In Canada, for the most part, the majority of Canadians cannot write off their mortgage interest expense against their income tax; in the US, they can. This deters most Canadians from “hanging on” to their mortgage longer than necessary as there is no benefit to paying interest any longer than one has to.
Finally, one of the best features of US mortgages is that there are no prepayment penalties if you decided to break your mortgage prior to its maturity. Although this is a very consumer friendly feature, it led to serious issues in the US with “Teaser Rates”. Clients were offered an introductory rate for the first year or two of their mortgage with the understanding that when the rate “reset” in a couple years time, they could just payout their mortgage with no penalty and refinance into a longer term or better rate. This was a strategy that worked as long as rates didn’t increase and housing prices didn’t decline. Unfortunately, that was not the case and we all know the result.
But that was the US and this is Canada. Here, north of the 49th, there is little reason, if any, to hang on to your mortgage longer than you need to. In light of this, most Canadians choose to pay down their mortgage as quick as possible and recent changes to mortgages by the government, ensure that houses cannot be used as ATMs and constantly refinanced to take out all the equity. That paired with lower amortizations cause mortgage balances to decline, equity to build up and the chances of defaulting decline. This is one of the reasons mortgage delinquency in Canada is one of the lowest globally.
While there are always market factors that cannot be predicted, like rising rates, home owners can insulate themselves against these situations by taking advantage of accelerated payments, prepayment privileges and talking to your Dominion Lending Centres mortgage professional about a personalized plan to rid yourself of that mortgage and ensure there is nothing scary lurking around the next corner.