Extended mortgages keeps housing market pumped

The residential housing market is on steroids.

This is not a metaphorical comment on how strong the market is. In fact, the financial equivalent of steroids is helping to keep people buying homes despite the fact that they're getting increasingly less affordable.

The technical name for the homebuyer's little helper is the extended amortization mortgage, which lengthens the time it takes to repay a home loan to 30, 35 or 40 years from the traditional 25. These mortgages shrink your payments, even while they extend them in years and lard in tens of thousands of dollars in extra interest. Net effect: Home buying is more affordable.

Extended amortization mortgages are such a factor in the marketplace that RBC Economics cited them in a report yesterday, saying housing affordability experienced one of the largest and broadest quarterly drops since the mid-1990s. Prices are soaring way beyond income gains, but extended mortgages are taking the edge off by keeping actual payments manageable.

"You can't make a forecast for housing markets without considering what's happening in the mortgage market right now," said Derek Holt, assistant chief economist at RBC. "Our estimate is that industry-wide, across the country about 20 to 25 per cent of all mortgage applications are now going longer than 25 years, and the 40-year mortgage is by far the most popular."

RBC said it took 46 per cent of a family's pretax income to afford the costs of owning a standard two-storey home nationally as of June 30. This reflects provincial rates that top out at 68 per cent in British Columbia and bottom out at 34.5 per cent in Manitoba. It's worth noting that lenders like mortgage applicants to be in a position where all their debts, not just the mortgage, account for no more than 40 per cent of their gross income.

Mr. Holt said that by using an extended amortization mortgage, a home buyer dials affordability back to the levels of 18 to 24 months ago. For lenders and real estate brokers, this is great news. "I think these mortgages breathe roughly an extra couple of years life into housing markets, although in some of more heated western cities it's even shorter than that."

For home buyers, extended mortgages are a potentially dangerous drug, and not only because they charge so much extra interest and keep you in debt longer. They also encourage people to take a plunge into a housing market that is approaching overheated levels in parts of the country.

Housing actually pulled back slightly in 2006 compared with the previous year's levels and analysts and real estate types called it an overdue and healthy move. With the use of extended amortization mortgages on the rise, however, sales in 2007 have kicked higher again. Last month, the Canadian Real Estate Association revised its estimates for the year to new record levels in most provinces.

Extended amortization mortgages are hot stuff right now because we live in a "gotta have it" culture where debt is the great facilitator. Mostly, these mortgages are a way for people to get into a home when traditional measures say they can't afford it.

To be fair, extended mortgages can make sense for certain buyers. Stan Falkowski, president of the mortgage broker Mortgage Intelligence, said prime customers would be people who have a job where income will increase rapidly so that they can ramp up their mortgage payments and cut their overall interest bill; a young doctor or lawyer, for example. "For someone who has limited potential for increased income, this is not a good option," he said.

Same goes if you're the sort of person who would be tempted to use the extra cash flow you get from lower monthly payments to rack up more debt, say buying furniture or electronics for your home.

RBC's Mr. Holt said the market you're buying into also has a role to play in the decision on whether to use an extended mortgage. He said he would be less concerned about taking a 40-year mortgage in a hot real estate market like downtown Toronto or Vancouver than he would in a depressed rural community.

To put today's housing affordability numbers in context, they are more favourable than they were at the end of the 1980s real estate boom. For example, the national rate peaked at just above 50 per cent in 1990 - a household needed more than half its pretax income to cover housing costs - while Toronto's rate hit almost 70 per cent.

To me, the 40-year mortgage sounds too much like someone elbowing you in the ribs and saying: "Hey, just swallow one of these babies and buy that expensive home. Who cares about the side effects?"

(prepared by Rob Carrick/Globe and Mail)