Mortgages move into unchartered waters

Liberalization of the Canadian mortgage-insurance market and the advent of 40-year amortizations are driving the housing market into "uncharted waters" with unknown risks, according to a Scotiabank report released Monday.

Recent innovation in the Canadian mortgage market has been conservative and lacks the dangers of the U.S. subprime fiasco, said Derek Holt, the report's author. Nevertheless, he warns, new approaches are "changing the longer-term risk dynamics in a way that gradually takes us toward a different mortgage market."

"If you continue to get take-up rates on these new products that are comparable to what we're seeing right now, then three, four, five years from now a significant enough share of the total mortgage book will have gone into a totally different suite of products compared to anything that's characterized our mortgage market in the past," Holt said.

Longer-term amortizations now account for three-quarters of all monthly insured-mortgage applications, with the 40-year product accounting for half of that, the report said.

In the near term, their introduction -- which began in 2006 when Ottawa "unshackled" the Canada Mortgage and Housing Corporation from the traditional 25-year mortgage -- will help stabilize a softening Canadian housing market as it draws in a new group of buyers.

Longer term, however, nobody knows what the effect will be, Holt said.

If, for instance, buyers as a group tend to pay back the debt at an accelerated pace, it will increase the risk for the originators of the mortgages and buyers of mortgage-backed securities into which they are folded.

On the other hand, the report says, "future shock risk is being intensified," in the event that a large portion of new buyers move into such leveraged products and suddenly face a shock to interest rates or wage growth.

Now, if faced with sudden difficulties, the holder of a 25-year mortgage can move into a 40-year, but it's unclear what would happen if the 40 becomes the norm and economic difficulties arise.

"That's uncharted waters for the Canadian mortgage industry," Holt said.

Equally significant is the impact changes to the mortgage industry may have on the condo market, Holt said.

Starting last year, Ottawa changed the rules on insured-investor mortgages, allowing buyers to acquire an insured mortgage on a property other than a principal residence.

Holt said he estimates one in four condo buyers is a speculator looking to profit from property price gains and, he forecasts, "This is going to intensify influences of investor sentiment, particularly the condo market over the next few years.

"You'll see more speculative activity in the market at a time when there's already a fair amount."

This can sharpen market downturns, as appears to be the case in Calgary, when prices drop and speculators rush to unload properties.

(prepared by John Morrissy/Vancouver Sun)