Down payment rule change won’t alter much
By Rob Carrick - Globe and Mail
Murphy’s Law, adapted to the Toronto real estate market of spring, 2007: What can become more expensive, will become more expensive.
House prices and mortgage rates certainly conform these days, but there’s one glaring exception. Effective immediately, you can avoid the hefty cost of mortgage-default insurance if you make a down payment of at least 20%, down from the old standard of 25%.
In theory, a home buyer could save a few thousand dollars as a result of this change, which was announced late last week by the federal government. Most people add the cost of mortgage-default insurance to their loan principal, so the new measure could also save people thousands in interest charges over the years.
In the real-life Toronto housing market, though, it’s unlikely that very many people are going to save on mortgage insurance premiums.
To understand why, let’s check in with mortgage broker Jim Tourloukis, president of Verico Advent Mortgage Services in the Toronto area. Mr. Tourloukis said about half of his clients have had a 25% down payment, and that virtually no one came in the door with 20%.
Some people are determined not to pay mortgage insurance, and they’ll save for however long it takes until their down payment is large enough. The new down payment rules won’t save these people any money, just get them into the market sooner.
“Essentially, you get to save less to avoid mortgage insurance,” Mr. Tourloukis said. “So it allows you to buy quicker, rather than saving another six months or a year.”
The other half of Mr. Tourloukis’s clients have little hope of saving a 20% down payment. He divides these people into three groups: Those with 10 and 5% down payments, and those with zero. These people are considered to be greater default risks and, as a result, they’ll continue to pay mortgage insurance premiums ranging from 2 to 3.1% of the purchase price of a home.
Given that the average house price in Canada was $316,572 at the end of the first quarter (up 9.5% from March, 2006 - there’s Murphy’s Law for you), these mortgage insurance premiums could easily add $5,000 to $10,000 to the purchase price of a home. Combine these amounts with your mortgage principal and the costs rise even further.
Mortgage rates rose about 0.2% across the board this month, and a good rate for a five-year mortgage is now 5.24%. If you were to add an insurance premium of $5,000 to a mortgage at this interest rate and amortize the whole thing over 25 years, you’d end up paying about $3,245 in extra interest (assuming you made payments every two weeks instead of monthly).
Current mortgage-default insurance rules have been in place for more than 30 years. The federal government opened these rules for comment a couple of years ago as part of a regular review of financial services legislation, and people in the mortgage industry spoke out in favour of the status quo. The gist of their argument was that relaxing the requirement for mortgage insurance would put them in a position of having to charge less-creditworthy customers extra for mortgages to cover off the risk of default.
Ironically, Bank of Montreal and Royal Bank of Canada jumped on the announcement of the lower down payment requirement last week. RBC produced some poll results saying it means more Canadians are likely to buy a home, while BMO said it stood ready and waiting to give its customers access to any cost savings they might realize.
The people most likely to save money are those who have already come up with a 25% down payment and are ready to jump into the housing market. They’ll now have the option of putting down just 20% of the purchase price and then using the other 5% for closing costs or to buy new appliances and whatnot.
There’s a geographical element to this as well. If you live in Toronto, Calgary or Vancouver, where average house prices range from $365,285 to $554,941, then you’d have to be quite the saver to amass a 20% down payment. In cities like Winnipeg, Windsor, Ont., and Saint John, where average prices are below $200,000, you’ve got a much better chance of hitting that threshold.
Another group of people who will benefit from the new rules are those who are big users of home equity lines of credit. Where previously you could spend up to 75% of the value of your home with your credit line, you can now go up to 80%.
Over all, the new down payment rule won’t do much to alleviate the ever-rising cost of buying a home. But it is an exception to Murphy’s Law as applied to the housing market, and that’s something.
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