Monday, March 03, 2008

Negative consequences of 40 year mortgages - I agree with this post

40 year mortgages did improve affordability for many first time buyers but there are negative consequences with these very long term mortgages
40 year mortgages also increased the amount that move-up buyers could afford. On the other hand, I agree with the article below that 40 year mortgages spell trouble for people who can't handle the huge debt load.

New mortgage products spell trouble

Ms. Vaz-Oxlade's advice: "If you can't afford a downpayment, don't buy."
'When I see this kind of unrealistic optimism ... it makes me scared for people,' says Gail Vaz-Oxlade.
Offering 40-year mortgages and no-money-down options to people who don't know how to budget 'is like taking a child into a candy store and telling them to eat anything they want,' one adviser tells Linda Mondoux.

If it were up to Gail Vaz-Oxlade, host of HGTV's popular Til Debt Do Us Part reality show on ordinary Canadians trying to dig themselves out of financial messes, no-money-down mortgages would be against the law.

And so would 40-year amortizations. And lines of credit wouldn't be handed to first-time homebuyers to finance their closing costs.

While these new mortgage products are being touted by lenders as great opportunities for young buyers to get on the property ladder, Ms. Vaz-Oxlade sees them as "nothing but trouble."

"What I am seeing in the real world is tremendous financial ignorance," she says, her voice booming over the telephone from her home near Cobourg. "They have no concept of the long-term cost of borrowing. They only focus on the payment -- the lowest possible payment, not accelerated payments.

"The problem with 40-year mortgages and no-money down is it doesn't prepare you to be a homeowner," she says. "Any fool can do that (get a high-ratio mortgage). But not everyone can be a homeowner."

Ms. Vaz-Oxlade chides the big banks for joining other lenders in adopting programs that she says have loosened the rules for mortgages and credit, "creating conditions right for default.

"It's almost as if we have rinsed our minds of 1990, when there was a correction in the real estate market," she says. "All markets have a cycle. When I see this kind of unrealistic optimism, that nothing bad will happen, it makes me scared for people."

The author of several books on consumer finances, Ms. Vaz-Oxlade accuses the banks of giving in by using a formula for credit scoring for mortgage purposes that is in conflict with sound lending practices.

The Certified General Accountants Association of Canada agrees that too much choice may be a bad thing.

"While lending institutions afford a beneficial service to society and its constituents, the risk tolerances of those institutions should not be exercised as a substitute for the judgment of individuals who must discern between good and bad credit," it says in an October report titled Where Does the Money Go: The Increasing Reliance on Household Debt in Canada.

The report points out that Canada's household consumer debt reached the $1-trillion mark in 2006 and has been climbing since, a trend Ms. Vaz-Oxlade's show and her website at www.gailvazoxlade.com try to reverse.

But it's not easy. An upcoming episode will feature homeowners whose monthly mortgage payments are financed from a line of credit.

"They're the perfect example of someone who is not ready for home ownership," she says. "Shame on the financial institutions for giving them a mortgage and a line of credit."

Ms. Vaz-Oxlade says offering 40-year mortgages and no-money-down options to people who don't know how to budget is "like taking a child into a candy store and telling them to eat anything they want. We're not educating them about the consequences."

But Mary Ellen Brown, director of home equity financing at the Royal Bank of Canada, defends her bank's decision to offer no-money-down, 40-year mortgages as "a good choice for some clients."

Those products, she says, are the result of a recognition by the financial industry that the cost of homes in Canada is going up, and more people want to own their homes. "It's still more attractive than renting," she says, adding that if things worked the way Ms. Vaz-Oxlade wanted, many people would be "missing an opportunity to build equity and real wealth."

Ms. Brown says the banks have not loosened their credit standards, "because you still need the capacity to repay." The checks and balances at RBC, she says, would deny a mortgage if there was a history of bad credit.

"Just because someone has opted for 40 years doesn't mean they have bad credit," she says, adding that RBC doesn't approve longer amortization mortgages without first discussing all costs -- such as default insurance premium surcharges -- and options -- such as accelerated payments -- with the borrower.

"It is our duty to make sure a client goes into this with their eyes open," she says, pointing out that the bank's online mortgage calculator is one of the few that shows potential borrowers how much interest they would pay over the life of the mortgage.

Ms. Vaz-Oxlade isn't convinced. Her advice: "If you can't afford a down-payment, don't buy."

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Mortgage Options

Amount of mortgage: $200,000

Mortgage term and rate: 5-year at 5.85%

Amortization period: 25 years

Payment schedule: Accelerated weekly

Weekly payment: $315.46

Mortgage balance after 5 years: $171,819.25

Cost over lifetime of mortgage

Total payment: $345,762.93

Total interest: $145,762.93

Amount of mortgage: $200,000

Mortgage term and rate: 5-year at 5.85%

Amortization period: 25 years

Payment schedule: Monthly

Monthly payment: $1,261.84

Mortgage balance after 5 years: $179,289.98

Cost over lifetime of mortgage

Total payment: $378,548.84

Total interest: $178,548.84

Amount of mortgage: $200,000

Mortgage term and rate: 5-year at 5.85%

Amortization period: 40 years

Payment schedule: Accelerated weekly

Weekly payment: $267.48

Mortgage balance after 5 years: $186,270.32

Cost over lifetime of mortgage

Total payment: $426,831.36

Total interest: $226,831.36

Amount of mortgage: $200,000

Mortgage term and rate: 5-year at 5.85%

Amortization period: 40 years

Payment schedule: Monthly

Weekly payment: $1,069.91

Mortgage balance after 5 years: $192,605.48

Cost over lifetime of mortgage

Total payment: $513,547.74

Total interest: $313,547.
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A. Mark Argentino
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