Monday, January 26, 2009


As in 25%, As in 25 years...

Once upon a time, back in 1989, to buy a house in Canada, you needed to put down 25%. In the last housing bubble (1989/90), prices collapsed once the early 90s recession kicked in and as interest rates soared in an effort to kill inflation.

As prices soared, in 1990, 5% down payments were introduced to make houses more "affordable" (sound familiar?), with mortgage insurance to theoretically insure the lender (ie bank) from the risk of a loss. In 1992, the RRSP Homebuyers Plan was set up (post price collapse) to make it easier to make a downpayment, in an attempt to put a bottom in the Canadian housing market.

For decades, a 25% down payment was necessary. What was magical about 25%? It probably represented the hit that a bank would need to take to repossess your house and sell it via an agent. Banks don't want to be homeowners, and thus will take a hit to free up the capital. Plus, as anyone who has ever studied business knows, a bank is supposed to want the investor/owner to have some "skin in the game". Otherwise, at 5%, the bank is basically the real owner and the homeowner has little invested.

I don't believe that governments can stop the freefall that the economy is in right now, but that won't stop them from trying. I would look for:

1) An increase in the RRSP Homebuyers Plan at some point (tomorrow's budget?) from $20K to $25K. $20K in 2009 dollars is worth a lot less than $20K back in 1992. I doubt that this would cost much overall and it would be popular. Also pretty cheap given the billions that the government is likely to spend or waste in its stimulus package. The real estate industry is already lobbying for this.

2) The other thing that the government is loathe to do since it will get blamed for further hurting the housing market, is to curtail or end the 5% downpayment insurance scheme. I will admit that there are probably some people for whom a 5% downpayment makes sense. For example, a doctor who is ready to practice (and mint) and who has a lot of student loans. For most families, though, a 5% downpayment is risky. Perhaps the government will not tinker further with Overprime Lite, but I would imagine that the Big Banks are already planning to ask for more "skin". It all depends on how much these mortgage insurers are going to lose (ask Freddie and Fannie?).

3) Amortizations of 25 years were the maximum until recent years. Same logic as increasing the down payment. Too long an amortization means no skin in the game.

Before the housing market can bottom, I believe a 20% to 25% down payment is going to come back. I believe a 25 year (worst case 30 year) amortization is going to come back.

Can you imagine what this is going to do for first time homebuyers? The average Canadian house sells for about $300K (and much more in many major cities). A 25% downpayment on that runs you $75K. Right now, a 5% downpayment runs you only $15K, less than the price of a new car (assuming you actually bought it with cash). So if you are interested in the $300K house, you would have to spend years saving more money (pushing demand to the future), you could wait until prices fall further (again pushing demand to the future) or you could settle for a cheaper house, although not too many 25% houses that you could buy with only $15K ($60K house). Add about 5 or 1o years less amortization (ie higher mortgage payments) and you have a recipe for disaster.

Imagine a 25% in $800K Vancouver? Not many people could put down $200K!

Just this one change (that is apparently already happening in the US) could really kill the Canadian housing market, excluding all the other negatives out there.

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