Thursday, January 30, 2014

Canada Has No 30-Year Mortgage

The housing finance market is very different up north:

The standard mortgage in Canada isn't the 30-year fixed, as it is in the U.S., but a five-year mortgage amortized over 25 years. That means the loan balance has to be refinanced at the end of five years, exposing the borrower to any increase in rates that has occurred in the interim. Prepayment penalties for borrowers hoping to exploit a decline in rates, on the other hand, are very steep. 

This looks as if it's a clear win for banks, which are minimally exposed to increased rates and protected from prepayments. But Canadian mortgages are also portable -- if you move before the five-year term is up you can apply your old mortgage to your new home. (If it's a more expensive home, you take out a new loan for the excess.) That restores some of the balance in the borrower's favor.

More important, observed Canadian economists Arthur Donner and Douglas Peters in a 2012 report for the Pew Charitable Trusts, the short term of Canadian mortgages allowed them to be funded from local short-term bank deposits at retail bank branches. The mortgage-lending system in Canada to this day resembles the American banking system up to the 1970s, when deregulation took hold and placed fancy, risky and careless lending at the center of the business model. (By the way, mortgage interest isn't tax-deductible in Canada, so there's no incentive to over-borrow.)

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If you'd like to live in a society where mortgages are smaller and shorter, freeing up one's wages for other purposes, consider this approach. Instead of taxing wages, instead of taxing sales, instead of taxing buildings, concentrate our taxation on land value. Collect for public purposes the lion's share of the annual rental value of the land (quick and dirty, 5% of the selling price of the site, in the absence of taxes). Were we to do this, houses would change hands at more or less the depreciated value of the structure itself, which in most places is 25% to 50% of the total property value; so we would need to borrow far less and could pay it back over far fewer years. And the sum of our mortgage and our taxes under that scenario would be far less than it is now. Land speculation would disappear, and with it, the boom-bust cycles that burden us all (or have we already forgotten the lessons of the last decade). Houses in hot markets would no longer be ATM machines, and foreclosures would be far less common. Sprawl would be slowed, even reversed. Housing would become affordable for people of all ages, stages and income groups.

Something to think about.

Posted by: Wyn Achenbaum | Feb 4, 2014 7:18:51 PM

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