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Wednesday, September 20th, 2023

Here’s what’s really scary about high-ratio mortgages in Canada

Canadians buying (overpriced) houses this spring with little money down, now face an additioimagenal burden with the recent announcement by CMHC – quickly followed by Genworth — that mortgage insurance will rise in price come June 1 of this year. Remember, this is the (bizarre) coverage that most homebuyers must pay for, which protects and indemnifies the lender in the event they (the homeowner) defaults.

Postmedia News
Postmedia NewsSchulich School of Business professor Moshe A. Milevsky says homeowners with high ratio mortgages don’t realize the “risk pool” they have stepped into.
Absurdly, this insurance stands in contrast to every other policy known to mankind, where the insurance premiums you pay are meant to protect you and not the payee. In contrast, with mortgage insurance you pay the premiums now when you buy the house and then in the event something horrible (financially) happens in your life, your banker won’t have to share in your misery.

Pity the high ratio mortgagor – a euphemism for buyers with very small down payments — who must now spend an additional 3.6% of the amount borrowed if they are only putting down 5% of the value of the house. And, the 3.6% insurance premium assumes a traditional form of down payment. For the non-traditional homebuyers, the premium rate is 3.85%. This, of course, is in addition to closing costs, land transfer taxes, moving expenses. Be prepared to spend.

But what really alarms me is what happens to these high ratio mortgage buyers and their spending after they have finally closed the deal and moved into their dream house. To be honest, I’m not sure they realize what a “risk pool” they have stepped into. Let’s look at the numbers.

The table below tells a scary tale. It is based on my analyses of Statistics Canada’s report on Survey of Household Spending. The data are somewhat stale – and worth monitoring very closely, if it were up to me — but based on anecdotal evidence the numbers are even worse today. Either way, here is what these sorts of numbers are saying very loud and clearly.


Where does the money go? Look at the first column. The 3.7 million Canadian home owning households without a mortgage – lucky them – have a disposable income (after income taxes and transfers) of $57,000 per year. They spend approximately 15% of their disposable income on shelter. Obviously, they don’t have a mortgage, so they don’t have to make any mortgage payments. But they still have to spend money maintaining and sustaining the house. They ‘burnt’ the mortgage long ago, but the bills do keep coming. Again, they spend 15% on housing and approximately 18% on transportation, 13.4% on food and 7.5% on recreation. No surprises really, or anything very interesting quite yet. But, here is the good news. Households without any mortgage payments to make actually save 14.7% of their disposable income, which is actually higher than the national average. Indeed, perhaps this is the reason so many Canadians look forward to the day they can “burn” their mortgage documents (perhaps at age 75, at this rate.)

Now look at second column, which represents the entire group of 4.9 million Canadian home owning households with (any) mortgage debt. They actually happen to have a higher disposable income of $73,700 compared to those in the first column, perhaps because they are younger and/or still working. Interestingly, they don’t appear to spend any less percentage wise on transportation, food and recreation. Yes, they obviously spend much more on shelter, approximately 30% of disposable income because they do have a mortgage after all. But even those households with mortgages still manage to eke out a savings rate of 3.5% of disposable income. Not great, but positive and closer to the national average. (Math point to remember: X% of disposable income is less than X% of gross pre tax income.)

Now, if I didn’t know better than to be deceived by simple averages, I would (erroneously) conclude that Canadians would be OK. After all, even those with mortgage debt are still managing to sock away money for retirement and/or a rainy day. They are a prudent bunch.

But as we all know, you can drown in a pool with an average depth of a foot. Analogously, let’s take a close look at the Canadian families who live in the deep-end of the risk pool.

Now look at the third and final column in the table; the one I believe is the scary one. This summarizes the spending life of the 1.8 million Canadian households who have a mortgage liability ratio (MLR) larger than 20% of disposable income. Recall, this implies that they are spending at least 20% of their after-tax income to cover the mortgage (only). On a pre-tax basis this number is higher and this figure doesn’t include maintenance, property taxes, heating or utility bills and all the other things one needs to avoid freezing in the winter or melting in the summer. The 20% of disposable income (only) goes to keep the bank at bay.

Oddly enough or perhaps by force of habit, these 1.8 million households continue to spend a similar fraction of their disposable income – compared to their less leveraged counterparts — on food, recreation and transportation. They long for the house and need to furnish it as well as keeping up with the local Joneses.

Alas, with over 20% of disposable income going to the bank, what gives in the family budget? You guessed it, savings. Whether it be for retirement or even an emergency, there is no money left at the end of the month. They don’t save.

Well, actually, it’s worse.

These 1.8 million households are taking a (1.) highly leveraged bet on the continued appreciation of housing, and (2.) aren’t willing to reduce their discretionary consumption to account for the new risks on their balance sheets. Look carefully, they are actually saving -13% (dissaving 13 per cent) of their disposable income.

How exactly do you dissave 13% of anything? Well, by foolishly buying things on credit cards, perhaps refinancing their mortgage every few years and spending some home equity, or perhaps other non-traditional (i.e. off-balance sheet) methods of borrowing. Anecdotally, again, my understanding is that parents and family members are yet another creditor of the high ratio mortgagor. Their home is the nest egg.

Yes, “but Cassandra” I am quickly reminded by every bullish realtor and agent in town, “the pricey house is their big savings.” After all, the promoters assert with confidence, if housing continues its steady march to the clouds we will all retire rich. “Why bother with any other forms of saving?” they ask.

Well, if you work your way backwards, the amount by which housing prices would have to appreciate over the next 10 to 15 years to justify negative savings rates — and still leave a decent liquid nest egg for retirement – is staggering. Personally, I can’t get the math to work out even in the shallow (i.e. small mortgage) end of the risk pool, let alone the deep (i.e. big mortgage) end. And, worst case scenario, if real estate disappoints and/or interest rates swell, just when it comes time to renew your mortgage in three to five years, well, I guess these 1.8 million Canadian families will learn what it’s like to run their house like a hedge fund.

Moshe A. Milevsky is a professor at the Schulich School of Business at York University, and author of the recently published book: King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past, Cambridge University Press (2015.)

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