HOW NOT TO HELP

It is widely accepted that a modern democracy cares more about the public perception of policy than its effectiveness. If you don’t believe that statement then a simple rewind of your Google search to the rhetoric surrounding issues like Obamacare and raising the debt-ceiling should be evidence enough. There are other policies, many outside of the US, that seem to go completely unnoticed by the public, or are even touted as a great thing for the public, when they are actually serving to undermine the very public that endorses them.

An example of this ignorant acceptance of a policy (that I have always been critical of) is the elimination of longer amortization mortgages to the Canadian public. The policy is one thing, but the positive press regarding the policy is outrageous. Back in 2011, the Globe and Mail had an article called “Good riddance to 35-year mortgages” (found here) that was precisely this kind of positive press. The article makes the case that the 35 year mortgage was simply too long and that “even 25 years seems too long to spend paying off such huge debt.” According to a BMO poll (also from the article) most Canadians agreed with BMO stating that “(56 per cent) think a shorter amortization period is a good thing, with those aged 35 to 44 the most inclined to agree (77 per cent).” I struggle to find another contemporary example of such a gross misunderstanding of the costs and benefits of a policy.

The benefit of this policy is skewed heavily in favor of powerful lenders and away from the borrowing public. Since the beginning of the low-interest rate environment, rate competition between lenders was so marginal that it was making very little optical difference to their customers (borrowers). In order to compete, the only move a lender had was to extend their amortization thereby lowering the cash flow required from the borrower. Extending the amortization put the lender in a risky position since the borrower would have more of the lender’s money for longer. Lenders were forced into this kind of risk competition instead of a more typical price competition. In order to prevent competition, lenders could set a price and an amortization that they could all live with and all make money at an agreed upon risk level.

The problem for the lenders is that this solution is a type of collusion, and collusion between competitors is illegal as stated by Canada’s Competition Act (which exists in other forms in other countries as well). So how do you get around a policy that is preventing you from colluding with your competitors? The answer is simple – just enact another policy that mandates the collusion that you are looking for. The policy in question would force lenders to take their 30, 35 and 40 year products off the shelves and, with only shorter amortization available, lenders would no longer have to compete in terms of amortization.

The next step was to sell this change as a benefit to the borrower. Before the removal of these products, the borrower was “forced” to be in debt for 30, 35 or 40 years, or so it was commonly claimed. A 35 year amortization does NOT mean that the borrower will be in debt for 35 years, even the Globe and Mail article acknowledges the benefit of prepayment options. Many mortgages allow you to pay 20% of the principle in any given year, which means that you could pay the whole thing back within 5 years, even with a 35 year amortization! Using prepayments can convert your long amortization mortgage into a short amortization mortgage. The article uses a simple calculation to show how much more interest a borrower would pay with a longer amortization than a shorter one. This is a completely bogus example since it does not take into account the time value of money or the prepayment option in the longer amortization which would serve to lower your interest payments.

Getting rid of longer amortization mortgages just means that you lose the option to pay less each month, it does not mean that you MUST take longer to pay it back. A longer amortization means lower monthly payments, which can be a life saver for those with a small business or variable income (commission-based income or other performance-based income).

It is also important to note that High Net-Worth (HNW) individuals are still able to get those long amortizations by finding lenders that are not covered by the policy, working with “friendly” institutions that vie for their business or borrowing through a legal loophole like setting up a corporation for a specific purpose. The general non-HNW public, in turn, are given fewer options in how to purchase a home.

A common rebuttal to my position is the observation that people who are entering the real estate market are often bullied into buying a more expensive home because they can afford a longer amortization. This is true, but shorter amortization does not fix this problem. People are still bullied into the same situations with shorter amortizations since the lenders' metrics are based on cash flow, and those metrics have not changed. The only difference is that the lenders are now getting their money back more quickly, which is an extra burden on the borrower and lower risk for the lender.

The correct solution is to educate the borrower of the risks that exist with debt and mortgage products and present them with all available options. Instead we accept that the general public is unable to be educated in this manner and enact a policy to protect lenders by mandating their collusion. If that’s your idea of help, then please stop helping.