No Money Down: Big Risk in Future

No money down; big risk in future
Covers legal, other fees: Debt premised on assumption
house prices will rise
Wednesday, October 05, 2005
For some people, borrowing 100% or more of a home's purchase price is the ultimate
speculative tool for getting in on the real estate boom. You'd have to think that
someone willing to take on that ratio of mortgage debt must believe house prices are
going to keep on rising.
But while there may be an element of this in no-money-down mortgages, experts say
the emotion of owning a home may actually be trumping more practical
considerations. They also say that even those who do have faith in real estate
investing might want to shift their thinking away from where rates and prices are
headed, and take a more balanced approach to their overall debts.
Paul Mims, vice-president of CIBC Mortgages, jokes that the 100%-plus borrowing
tool is actually paying him to buy a home on Toronto's tony Bridle Path. Kidding
aside, this kind of borrowing is likely premised on the assumption that house prices
"will keep rising forever," he says. "We've got a short memory, but house prices are
only up in a strong economy. Just around the corner they could drop, and you're
going to have to pay it all back."
Mr. Mims does say the product might work for one of the target markets cited by
advertisers --young professionals like doctors and lawyers who have great credit and
strong income potential, but also have big student loans and no savings.
But that's really just a marketing tool, and few people in this category are actually
going for no-money-down mortgages, according to Vince Gaetano, senior mortgage
consultant with broker Monster Mortgage. "It really tries to tempt the people who are
keeping up with the Joneses," he says. "When you go over for that dinner party, you
don't see the type of mortgage product they have plastered on the front door."
If they did post their mortgage costs for everyone to see, a 100%-plus borrower
would no doubt surprise the neighbours with 150 extra basis points tacked on to their
rate.
Mark Goode, a consultant with Mortgage Intelligence, a broker owned by General
Motors Acceptance Corp., says he uses the company's 107% borrowing product, the
i107, in his "tool bag." It allows homebuyers to borrow over the cost of the home to
cover legal and other fees.
But there's a big premium associated with this kind of mortgage. On a $300,000
home, Mr. Goode says an i107 client would pay on average 5.9% interest on a threeyear
fixed mortgage. That compares to a rate of 4.25% to 4.5% for a customer with
a 10% down payment for the same term, he says.
Comparing them is a bit like comparing apples and oranges, he says, noting the
different amount each client is borrowing, plus the fact that no-money-down
customers simply don't have the option of paying $50,000 or so upfront to cover fees
and a down payment.
Lori McLeod
Financial Post
For the sake of analysis, however, let's take a look at how much you'd pay off in
principal and interest over three years in these two scenarios, based on biweekly
mortgage payments, a 25-year amortization and interest compounded semi-annually.
Using the Mortgage Intelligence calculator, if you borrow 107% on a $300,000 home,
after three years you'll have paid off $18,658.23 of the principal and incurred
$54,496.76 in interest charges.
If you put 10% down, at the more conservative 4.5% rate, you'll have paid off
slightly more of your principal -- $18,884.42. But here's the big kicker: you'll have
only paid $34,913.15 in interest.
That means a 107% borrower pays $544 a month more in interest alone for the same
home. Plus, at the end of the three-year term, their mortgage will still be almost
$2,500 more than the price of the home. So that investment could actually end up
costing money, if the home's value has declined and the owner wants to sell.
Somewhat surprisingly, however, there's actually a lower forfeit rate on higherborrowing
mortgages, according to Mr. Goode. He puts that down to a more rigorous
screening process for people to qualify. The people who are more at risk of getting
into trouble, he says, are those who are taking triple advantage of low interest rates.
They qualified for higher-priced homes, borrowed for home renovations, and took out
lower-rate variable mortgages, and they could be sunk if rates go up.
The low-rate environment, combined with soaring hydro and energy costs, could
definitely get homebuyers with no cushion into trouble, says Mr. Gaetano. "There's no
wiggle room in houses. My income's not going up 30% like the cost of these staples."
In his opinion, part of the blame falls on Canada Mortgage and Housing Corp., which
"isn't responsible enough to look at revising qualifying ratios at times like this."
High-borrowing mortgages aren't intended for people looking to flip a house quickly
for profit, says Mr. Goode. But they are a good option for young professionals,
students who live in the dwelling (up to a four-plex) and rent the other units for
income, or newly divorced people with good credit but depleted savings after splitting
up their assets.
For the truly house-hungry who have no savings, Mr. Gaetano says they'd be better
off to exercise a little patience and reap the rewards of putting something down on
their homes. He leaves investors with a final thought to chew over when mulling a
100%-plus mortgage: "It's never no money down. It's a transaction that feeds a lot
of people -- realtors, bankers, appraisers, everybody else except you."
© National Post 2005