Good debt, bad debt, let’s talk about debt.
- The focus on lending restrictions needs to include if not at this point be shifted primarily to consumer debt, i.e. credit cards, unsecured credit lines, auto loans, recreational vehicle loans, etc.
- Current Government restrictions on mortgage refinancing limits potentially leave many clients with higher interest debt loads than they would otherwise have.
- No conspiracy theory, just unintended consequences of best intentions.
For many Canadians debt is debt, all bad and something to be free from as quickly as possible no matter how low the interest rate. For others it is a strategic tool enabling leveraged equity gains. For Government regulators it is an often-discussed concern. For lenders it is a profit center.
The delicate balance of regulations that account for the goals both of Government regulators while still allowing Financial Institutions to actively lend, in addition to the best interests of clients, has as of late arguably not been moving in favour of the borrower. Recently CMHC reported an 81% drop in home mortgage refinance activity due almost entirely (~98%) to policy changes introduced July 9, 2012. This can be viewed as a positive thing to some extent, yet there is a darker side with potentially deeper ramifications. i.e. more CDN’s are forced to carry higher interest debt for longer. Often people slip 10K, 20K, or 30K into debt during lay offs, dealing with medical issues, due to lack of insurance, or while assisting other family members, during the start up of a new business, etc. Contrary to popular sentiment all consumer debt is not Gucci handbags and Rolex watches.
Lets review the differences in interest costs of Mortgage (Good) debt as opposed to Consumer (Bad) debt;
Mortgage Debt – ***figures used are CDN average as per recent CAAMP report
$179,000 @ 3.06% yields ~$453.57 per month in interest earnings for a lender.
$27,000.00 @ 3.06% yields ~$68.75 per month in interest.
These are low interest rate loans with a reasonable repayment schedule secured by a largely stable if not appreciating asset.
25 year maximum amortisation in the case of insured mortgages.
The balance outstanding (Principle amount) is steadily declining and the majority of the payment becomes principal rather than interest over time. The lender earns progressively less on the debt with each passing month.
Total interest paid on the $179,000 example above is $94,098.07 or just 0.53 times the initial amount borrowed.
CDN mortgages have been, and remain, exceedingly low risk debt which is priced accordingly. The current qualification guidelines for a mortgage are extremely stringent. Keys to new houses are not being handed out with anywhere near the ease of keys to new cars, trucks, boats, sleds, ATV’s, or new luggage for vacations, etc.
My standard mantra; ‘Mortgage Money has almost never been cheaper, but it has never been so hard to access’.
Onward to the easy access debt;
Credit Card Debt
$27,131.00 @ 19% yields $413.50 per month in interest.
$179,000.00 @ 19% yields $2728.09 per month in interest.
These are high interest rate loans with a very low minimum repayment schedule secured by nothing material.
127 years is the effective amortisation in the case of a 27K credit card balance.
The balance outstanding (Principle amount) is hardly declining and the majority of the payment remains interest for decades. In fact the lender recovers an amount equivalent to the principal in 66 months (5.5 years), and from there forward each dollar of interest is pure profit even if the debt becomes uncollectable.
Total interest paid on the $27,000 example above is < $600,000.00 or 22 times the initial amount borrowed.
Personally I am unclear on how our Federal Finance Minister, ostensibly ‘very concerned’ with household debt, can allow an effective amortisation of 127 years on dinners out, tanks of gas, or particle board furniture that will not exist 10 years from now, let alone 127 years later. Yet that same Finance Minister is adamant that we pay off an appreciating asset in which we shelter our family within 25 years. Incidentally there are several 127 year old homes still standing.
Allowing an extra 5 or 10 years amortisation on a dwelling would apparently be too risky for the average CDN. Despite the fact that CDN’s have a strong record of paying down their mortgages years in advance ultimately. In fact BC residents are the most aggressive in the nation with regard to taking advantage of pre-payment privileges.
It seems that there is a disconnect from logic in the mix. Unless perhaps you are the lender, that is another story. Looking at the yields above, and factoring in the far reaching changes to slow mortgage lending, and arguably nonexistent steps taken to reign in unsecured consumer credit lending, one might be inclined to start thinking conspiracy thoughts. Personally having served on a housing strata council and witnessing the level of disagreement that can be achieved between parties with a seemingly common goal I am no longer a believer in conspiracies.
It is more likely that we have perhaps a bit too much focus on a topic (mortgage debt) that seemed, and perhaps was to a lessor extent, worthy of tighter regulation. If for no other reason than to allay investor concerns over perceived (not actual) similarities between the US housing market and that of Canada. 5 years after the Economic storm the CDN housing market has been resilient, our economy has been resilient and CDN Banks, unlike others in the G7, have not only NOT required bailouts, they are posting record profits.
Perhaps the record Bank profits are related to the deployment of greater amounts of capital into unsecured lending (highly lucrative) programs as mortgage lending has become more restrictive and remains lower margin business.
In any event things really do not add up entirely here. I cannot imagine what would happen to the economy if the same qualification standards were used when applying for a credit card, car loan, or furniture loan, as are used for applying for mortgage debt. No doubt the economy would slow down, however that might be better than a more abrupt event a few years further on.
One would be hard pressed to find a homeowner going through foreclosure today who at the time of mortgaging had two high-end vehicles leased, a boat financed, a camper loan and 30K+ in credit card debt. One would be equally hard pressed to find a foreclosure in which the ease with which additional consumer debt was piled on after the home purchase was not a key factor. Typically there is another element or three along the lines of physical health, mental health, un-employment, etc also factored in.
Thankfully only ~.31% of CDN homeowners find themselves in such situations currently.
99.69% of us make our mortgage payments on time every time. A clear sign of stability.
That said, the gigantic microscope that mortgage lending has been scrutinised under needs to be put to better use with regard to consumer debt.
As far as consumer debt, and its measurement as per the ‘debt to income ratio’ that we will pick up another time. After all, many of us may well have a $27,000 0% car loan, a $27,000.00 investment loan at 4%, or a $27,000 1.9% cash advance funding a small business venture but not many of us actually carry $27,000.00 at 19% year in and year out.
We will dig into debt to income and break down some of the concerns around that ratio soon.