Risk Sharing & Your Mortgage

Everything’s a risk these days. You can’t even kiss your dog for risk of contracting some zoonotic disease.

Even prime insured mortgages—where the odds of a borrower defaulting are less than your odds of being on a plane with a drunken pilot—are suddenly too risky.

Ottawa’s mortgage police claim they’re worried about the risk of shoddy underwriting so they’re making lenders share more losses when insured mortgages go bad. (More details)

Once the Finance Department’s new pain-sharing plan takes effect—which could happen within a year or so—mortgage costs are headed up.

Here’s some of what you can expect:

• Higher rates: Lenders will offset loss sharing with higher interest rates. Our best estimate after speaking with lenders and policy experts is that Ottawa’s changes will result in a 9-25 bps increase in insured rates, depending on the lender and mortgage. If you take an average and assume 17 bps, insured borrowers will pay $1,600 more interest on a standard $200,000 mortgage over five years. (Remember that only folks putting down less than 20% need to get insured mortgages, but bank challengers insure mortgages anyway because it helps with securitization.)
• Lower insurance premiums: Those putting down less than 20% currently pay default insurance premiums of 1.80% to 3.85% (today’s premiums). CMHC’s top brass say that insurance premiums should drop under loss sharing. Yay! Assuming lenders pay 15% of the insurer’s losses, this could save high-ratio borrowers anywhere from 0.25% to 0.60% off their premium. That’s $500 to $1,000 of savings on a $200,000 mortgage.
• Regional disparities:  If you live in a rural, remote, economically depressed or one-industry town, you’ll likely have fewer mortgage choices. That’s because, with loss sharing, lenders will steer clear of locations that present greater risk of loss. Or, they jack up rates on the poor borrowers who live in such areas. Currently, CMHC insures everywhere and assumes regional risk, so this is much less of a problem under the current system.

Net-net, loss sharing could easily cost Canadians more than it saves them, even after factoring in the risk reduction for Ottawa, which backstops all insured mortgages. Moody’s says insurers would lose $6 billion in a U.S.-style housing crash. But CMHC has made $20 billion for taxpayers since 2006, and has a $16+ billion war chest of capital (plus more in “unearned” premiums) to shield citizens from future losses.

We also shouldn’t forget that insured lenders (a.k.a., mortgage finance companies, or MFCs) have drastically improved mortgage discounts since their inception in the late ’80s. If you’re a Gen Y’er or millennial, you might not remember that banks (those little devils, we love ’em, don’t we?) used to sell mortgages at posted rates high enough to make your nose bleed.

Today, MFCs lend to borrowers (via brokers) at rates that are 15+ bps below bank rates, saving Canadians hundreds of millions each year. And they do so without gobs of risk. Only about one-tenth of one percent of MFCs’ securitized insured mortgages are in arrears.

The government’s own underwriting data doesn’t lie. It suggests the Finance Department is putting out a fire that isn’t even burning.