The Route to a Secure Financial
Future . . . . or Not?
This article was written by Lynn
Biscott and reproduced with permission from the January, 2007 Forum Magazine
This past year has been a rough one for those of us who preach financial restraint to our clients. Last February, Canada Mortgage and Housing Corp. (CMHC) announced that it would start insuring mortgages with a 30-year amortization on a four-month trial basis. The next month, Canada’s other leading mortgage insurer, Genworth Financial, not only followed suit, but upped the ante to 35 years.
Then, in June, CMHC made the 30-year mortgage a permanent feature, matched Genworth’s 35-year bid, and played a new hand – they introduced the option of making interest-only mortgage payments for up to the first 10 years of the mortgage contract.
Not to be outdone, Genworth returned to the game in October with a 40-year amortization, and a deal with Scotiabank that would allow people to buy a home with no money down.
That’s where matters stood at the time of writing, but any day now, someone may offer eager buyers the chance to spread their mortgage debt out over 50 years.
The media releases that accompanied these new policies were full of platitudes. Genworth talks about “helping potential homebuyers with concerns about affording monthly mortgage payments”, while CMHC wants “to make home ownership more affordable and accessible for Canadians”. Admirable goals, for sure, but is increasing the cost of borrowing really the way to achieve them?
Let’s take a couple we’ll call Mai-Ling and Ephraim, looking to buy a $200,000 home. We’ll assume that current interest rates for a five-year term are at 6%. If they’re able to come up with a 25% down payment, they’ll be borrowing $150,000, for a monthly payment of $960 over a 25-year amortization. If they take the full 25 years to pay off the loan, they’ll have paid a total of $137,913 in interest – a shocking figure in itself for clients who may never have looked at this aspect of a mortgage.
But let’s say that they only have a $10,000 down payment, and they plan to borrow $190,000. With 5% down, Genworth’s insurance premium is 2.75% of the amount borrowed, or $5,225 in this case. While that amount can be paid in a lump sum at the time of closing, if Mai-Ling and Ephraim don’t have any more money for a down payment, chances aren’t good that they’ll have cash on hand for the insurance premium. In fact, Sherri Leclair, Marketing/ Communications Leader for Genworth Financial, advises that only 1-2% of borrowers pay the premium as a lump sum. So, that increases the amount that Mai-Ling and Ephraim will have to borrow to $195,225.
Have a look at how this will affect their total cost:
Amortization
|
Monthly Payment |
Total Interest |
|
25 years |
1,249 |
179,495 |
|
30 years |
1,161 |
222,826 |
|
35 years |
1,104 |
268,254 |
|
40 years |
1,064 |
315,563 |
Note:
Based on a mortgage of $195,225 at 6%.
Source:
www.mortgagecalculatorcanada.com
If
they have no down payment at all, Genworth’s premium goes up to 3.75%, or
$7,500 on a $200,000 loan. Now the picture looks like this:
Amortization
|
Monthly Payment
|
Total Interest
|
|
25 years |
1,328 |
190,779 |
|
30 years |
1,234 |
236,833 |
|
35 years |
1,173 |
285,115 |
|
40 years |
1,131 |
335,404 |
Note:
Based on a mortgage of $207,500 at 6%.
Source:
www.mortgagecalculatorcanada.com
If they go for broke, and take a 40-year mortgage with no money down, they’ll be paying almost 2 ½ times as much interest over the life of the loan compared to a conventional mortgage with a 25-year amortization. And this makes home ownership more affordable?
With buying houses as with buying cars or washing machines, too many clients equate the cost with the monthly payment – a lower payment means a better deal. When they’re playing with borrowed money, though, that’s not necessarily the case. The longer they take to pay off the loan, the lower the payment will be, but it will cost them more – sometimes much more – in the long run.
With consumer credit as with other financial products, new initiatives don’t always represent better deals for the client. If clients really want to make home ownership more affordable, they need to go back to basics – keep the borrowing to a minimum, either by aiming for a larger down payment, or buying a less expensive home. Spreading the debt load out over 40 years isn’t the answer.