By Ray Turchansky
Edmonton Journal
Wednesday, November 15, 2006

Also published in:

Amid the new world of mortgage options -- interest-only payments, no down payments, and 40-year amortization periods -- a Manulife Bank Canada survey says fewer than one-third of Canadian homeowners understand how much their mortgage will cost them.

Adrian Mastracci, fee-only portfolio manager at KCM Wealth Management in Vancouver, says, "By extending your amortization period greater than 25 years you most likely will pay more in interest than the borrowed principal, which essentially means you are long-term renting from your favourite mortgage lender."

"That is a staggering figure. We have a lot of work ahead," said Adrian Mastracci, financial advisor with Vancouver-based KCM Wealth Management Inc. "Paying off loans slowly, especially non-deductible ones, is one of the biggest impediments to accumulating the retirement nest egg."

He points out that with a $100,000 mortgage at 6.0 per cent calculated semi-annually, your payments are $565 a month and you pay $137,400 in interest over 35 years.

But if you increase your monthly payments to $640, you can knock a decade off your mortgage, and spend only $91,900 in interest over 25 years.

Furthermore, if you can manage payments of $840 a month, you will pay off the mortgage in 15 years and spend only $51,200 on interest.

Mastracci points out that by extending your amortization period greater than 25 years you most likely will pay more in interest than the borrowed principal, which essentially means you are "long-term renting from your favourite mortgage lender."

Yet a number of movements within the past year or so have actually enticed homebuyers and homeowners to take on more and riskier debt, and pay it off slowly if at all.

Things started when Canada Mortgage and Housing Corp. said it would offer mortgage insurance for interest-only loans, where no principal is paid off, while also offering insurance for amortization periods up to 35 years, compared to the traditional 25. Then the other major mortgage insurer in Canada, Genworth Financial Canada, said it would insure 40-year mortgages.

In October, CIBC World Markets released a report showing there had been a 50-per-cent increase in sub-prime mortgages. These mortgages often have weaker requirements, and are offered to new immigrants without a Canadian credit history, the self-employed without proven incomes, and to people with poor credit ratings.

While mortgage insurers and lenders say all these innovations are allowing more Canadians to buy more house earlier in life, critics argue that they are pushing Canadians into a quagmire of debt that will result in mortgage defaults and housing foreclosures.

Bank of Canada governor David Dodge blasted CMHC, saying that interest-only and 35-year loans would drive up home prices and make them less affordable for Canadians, contradicting the expressed mandate of the crown corporation. And while home ownership is usually championed because it builds up equity in a normally appreciating asset, many of these innovations allow little if any equity to accrue, causing critics to argue that those people would be better off renting.

"It worries me," said Moshe Milevsky, finance professor at York University in Toronto, well-known for his research on fixed versus floating mortgage rates.

"This is not being used by people who are well off and wealthy, it's being used by people who couldn't afford a house otherwise," he said. "If you couldn't afford five per cent down or have a conventional mortgage because your gross debt service ratio was greater than 30 per cent, reducing your payments means you're going to pay for your house three times. It's instant gratification."

Five years ago, Milevsky's study of five-year rolling interest rates during the previous 50 years showed that 88.6 per cent of the time homeowners would have saved money with floating rather than fixed-rate mortgages, specifically an average of $22,000 on a $100,000 mortgage amortized over 15 years.

Today's flat bond yield curve, which means you're paying only one-half to one per cent extra to lock in a rate long term, makes fixed rates much more attractive than five years ago.

"A new home owner putting in the minimum amount might need the insurance and maybe they should go fixed," said Milevsky. "But if I have a substantial down payment and can tolerate the fluctuations, I don't need the insurance."

About 40 per cent of Canadians currently have floating-rate mortgages.

"What puzzles me about fixed or floating is that it's speculation. It's a risk management question. Short rates are easier to predict, floating rates I can control. Where will fixed rates be -- I don't know where the bond market's going to go.

"But if you can only afford a floating rate mortgage because it is cheaper, then maybe you don't belong in a house."

Meanwhile, the Canadian Institute of Mortgage Brokers and Lenders estimates homeowners in Canada will have $808 billion in outstanding mortgage loans on residential real estate in 2007.

Aurele Courcelles of Investors Group suggests three tips to figure out how much house you can afford:

1. Incorporate your mortgage into your overall, long-term financial plan.

2. Consider which trade-offs you're willing to make, such as a smaller house to allow more lifestyle spending.

3. And manage your mortgage annually by considering re-amortizing, increasing payments, making lump sum payments, or "blending and extending" your mortgage while long-term rates are low.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.