US Mortgage Woes May Soon Affect Canadian Mortgage Industry

Even as the United States government agencies are homing in to endorse major mortgage lenders, such Freddie Mac and Fannie Mae along with IndyMac Bankcorp, experts are of the view that the problems in the neighboring country may well be a warning that Canada too may confront its own mortgage catastrophe soon. In a recent report, the vice-president and chief economist with Export Development Canada, Peter Hall has expressed concern that besides the housing problems in the United States, the housing starts in the United Kingdom too were trailing by 56 per cent year-over-year throughout May. In Spain, the housing starts were low by 18 per cent in the first quarter of the current year, while it was 17 per cent low in France year-over-year in May 2010.

At the same time, Hall observed that housing starts in Canada are currently ascending owing to the potency of the country's domestic economy as well as a substantial amount of an extremely sell-timed financial incentive. He is of the view that an enduring surfeit of housing starts compared to requirements signifies that Canada may also face a housing crisis soon.

It is important to note that Hall's report was made public following the Canadian government's endeavor to stay away from a housing crisis by not insuring mortgages with fewer than 35 years of amortization periods as well as below five per cent down payment on or after October 15, 2010 any longer. Henceforth, it will be necessary for people intending to purchase residential real estate and making down payment below 20 per cent to insure their mortgage through the Canada Mortgage and Housing Corporation (CMHC), a crow conglomerate, or any of the few private companies that have set footprint in the mortgage insurance market.

It may be mentioned that in 2006, the Canadian government had expanded the upper limit of the amortization period from 25 years to 40 years, totaling several hundreds of thousands of dollars in terms of interest expenses. In 2009, approximately 37 per cent of mortgages taken out were for periods more than 25 years.

Quick on the heels of the changes effected by the Canadian government, the United States Federal Reserve Board also curtailed mortgage lending policies. Starting from October 1, 2010, the Federal Reserve Board has made it necessary for the lenders to authenticate the borrowers' income with a view to determine the latter's ability to repay the mortgage. In addition, the income verification of the borrowers is also required to ascertain the ability of the lender to repay a loan from income into consideration, to set up escrow accounts for property taxes and, in certain instances, the home owners' insurance as well as to mainly publicize rates and payments with clear notice provided the rate is not fixed.

One of the many reasons that led the mortgage lenders in the United States to give mortgages to home buyers despite an unverified capability to make payments was that the lenders were able to tie the loans together with others and sell them to other financial institutions. In case these lenders were compelled to keep the liabilities with them, something that is a general norm in case of lenders in Canada, it may be assumed that mortgage lending would have been less irresponsible.

Instead of subsiding, the housing problems in the United States have been worsening with the passing of each day. In fact, adjusting the soft interest 'teaser' rates to the prevailing market rates that are comparatively higher are maxing out only now as people are anticipating foreclosures to inundate the market with residential real estate assets for sale shortly.

In fact, in the very first place, home buyers who do not have enough money for mortgage resets at mere five or six per cent ought to have never been allowed to undertake house payments.

However, it was an entirely different issue in 1982, when the Alberta government set up the Heritage Fund Mortgage Interest Protection Program with a view to recompense home owners for making payments above 12.5 per cent. At that time, the first mortgages were competing at anything between 16 per cent and 18 per cent which forced several families to take on second mortgages at higher rates - 22 per cent.

Over the years, the situation has worsened to such extents in the United States that, if necessary, the Federal Treasury department would be providing credit to major mortgage lenders Freddie Mac and Fannie Mae - the two organizations sponsored by the government which have sold almost 50 per cent of all the mortgages in America.

In fact, each of these government-sponsored enterprises (GSE) comprises a debt component as well as an equity component. The latter, equity component, has been declining in value since the investors have sold off their share owing to anxieties over escalating defaults by mortgage borrowers.

Jim Rogers, a renowned commodities investor in the United States, has described the plan of the Treasury as an 'absolute disaster'. According to Rogers, the mortgage lenders are mostly bankrupt and, in such a situation, the tax payers would be forced to pay the bill.

Simultaneously, different government agencies in the United States have intervened to acquire IndyMac Bankcorp, following their failure to rescue Bear Sterns for the economic mess. In fact, as things stand today, as many as 90 financial institutions of approximately a total of 7,500 monetary organizations in the United States those are on a watch list to go bust.

According to many, it was very much expected that with the government stepping in to save the mortgage lenders, the stock markets were bound to get a boost. Nevertheless, the investors' fears increase as the Dow Jones Industrial Average dropped.

In spite of the current developments, Adrian Mastracci, a portfolio manager with CKM Wealth Management in Vancouver, has some valuable tips to offer the home buyers. Mastracci's advices include:

  • As a first home, one should consider buying a townhouse or a condominium and subsequently go in for purchasing a separate house.
  • Homebuyers should always bear in mind that besides the purchase price of a home, they may also have to bear legal and realtor expenses, costs incurred in moving, furniture, renovation, repairs, maintenance, property taxes, utilities as well as insurance.
  • It is advisable to save 20 per cent for a down payment as it would help avoid paying additional fees, mull over obtaining money from one's registered retirement savings plan via the Home Buyers Plan and also do without making non-registered investments since the homebuyer would require an 8.9 per cent return to do better compared to making a down payment of 5.75 per cent of the mortgage provided he/ she is in the '35 per cent' tax bracket.
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