Carl Phin & Kim McLeod

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Do Canadians need 30-year mortgages? We're already on the verge of drowning in household debt

Edmonton Journal

By Ray Turchansky, Freelance

 Edmonton financial adviser Shawn Allen of Investors Friend Inc. has been prodding financial writers to lobby financial institutions to offer Canadians an "affordable" 30-year locked-in mortgage, insured and with minimum penalties for refinancing.

Allen argues that Americans can get 3.9 per cent mortgages locked in for 30 years, and can refinance relatively painlessly.

The idea raises two questions: Could it be possible in Canada? And is it prudent?

On the one hand, getting people into homes is deemed good for the economy, spurring spending and creating jobs. But on the other hand, Bank of Canada governor Mark Carney, federal Finance Minister Jim Flaherty, the International Monetary Fund, and most recently the Canadian Mortgage and Housing Corp., have warned that Canadians are already on the verge of drowning in household debt.

Mortgage lending rules have been tightened three times in the last two years, and many people feel that banks should make it even tougher for people to get mortgages, rather than easier. People are advising many wannabe homeowners to rent instead, to avoid getting killed by either a bursting housing bubble that could make the value of their home less than what's owed on the mort-gage, or by higher interest rates.

Variable mortgage rates are tied to the prime lending rate, but discounts on variable rates have mostly vanished during the past month, and people renewing or getting first-time mortgages are now being advised to lock in.

Fixed mortgage rates are tied to long-term bond rates. During the past 11 years, five-year Government of Canada bond yields have fallen from 5.0 to 1.33 per cent, while five-year mortgage rates dropped from 8.0 to 5.39 per cent. Longer term, 30-year government bond rates are 2.56 per cent in Canada and 2.98 per cent in the United States. In Canada, adding just the current five-year spread of 3.96 per cent would make for a 30-year mortgage rate of 6.52 per cent.

Regardless, Allen notes the key is that a mortgage interest rate be "affordable," and therein lies the rub. For some people, a mortgage at 10 per cent a year for 30 years would be affordable, while for others a mort-gage at zero per cent interest for 30 years wouldn't be.

In addition to interest, there's also the mortgage principal, legal and real estate fees, property taxes, home renovations, maintenance, landscaping, utilities and insurance, or condo fees.

In a presentation, Richard Goatcher, who heads CMHC in Edmonton, showed that the average local homeowner pays slightly more than $1,750 a month in mortgage principal and interest, down roughly $400 a month from 2007. In addition, a study by Sean Cooper shows that an older home requires you to spend three to five per cent of its value on maintenance and renovations each year - $15,000 to $25,000 annually on a $500,000 house.

A Royal Bank of Canada housing affordability study showed that during the third quarter of 2011, annual home ownership costs of a standard two-storey house ranged from 36 per cent of total household income in Alberta to 75.1 per cent in British Columbia.

But mortgage principal and interest represent only 67 per cent of house-hold debt in Canada. There are also lines of credit, car loans, credit cards, perhaps student loans and maybe in-vestment loans.

CMHC reports that from 2001 through 2010, consumer debt, mortgage debt and total debt each grew by an average of nearly 10 per cent a year. It warns that personal lines of credit have increased at double-digit rates annually since 1986, and now make up 25 per cent of household debt, compared with 3.0 per cent in 1986.

David Chilton, author of The Wealthy Barber Returns, warned delegates at last year's Canadian Pension and Benefits Institute western regional conference, that the biggest danger facing Canadians is private debt.

"People cannot resist lines of credit," Chilton said. "And the worst combination in the country is a line of credit and a home renovation - once they renovate one room, the other rooms pale by comparison, so they go on to the next room and it's a never-ending cycle of renovation as they get deeper and deeper and deeper in debt. The four most expensive words in the English language are 'while we're at it.' And the four most expensive letters are HGTV."

Canadians' ratio of debt-to-personal disposable income has grown to 152.96 per cent, a measure that people deem irrelevant as long as home values are increasing. But TD Economics says Canadian houses are overvalued by 10 to 15 per cent. Bank of America Merrill Lynch expects Canadian homes to fall five per cent in value during the first six months of this year, and 10 per cent if unemployment increases from the current 7.2 per cent to 8.0

Indeed, Peter Norman, chief economist with the Altus Group, told BNN television that rising interest rates don't affect home buyers as much as high unemployment rates do.

Rather than trying to emulate the American housing scene, we should learn from its mistakes. During the Bill Clinton presidency, Freddie Mac and Fannie Mae provided easily accessible funding that would get Americans to buy houses. And Federal Reserve chairman Alan Greenspan kept interest rates low for a long time, luring more people into peril that struck when interest rates inevitably rose.

As a result, at least 2.7 million American homeowners who took out mortgages between 2004 and 2008 have had their homes fore-closed upon. And another four mil-lion homeowners are expected to run into financial housing trouble in the next two years.

The result is that Americans are becoming renters rather than homeowners. During November, building permits in the U.S. went up 2.3 per cent for single-family homes, but a whopping 32 per cent for rental apartments.

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