Guest shot: B.C.’s homeowner loan program twice as expensive as government claims
The loan program will likely inflate the cost of entry-level homes and increase the probability of an ugly housing downturn, argues UBC professor Tom Davidoff.
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The B.C. government’s new Home Owner Mortgage and Equity Partnership (HOME) offers first-time homebuyers subsidized loans that allow down payments as low as 2.5 per cent.
By fuelling demand, this program will likely inflate the cost of entry-level homes in supply-challenged markets like Vancouver.
By encouraging people to take on more debt, the program will increase the probability of an ugly housing downturn.
The HOME program is also more expensive than the province has claimed.
The Ministry of Finance estimates that for every dollar of loan proceeds under HOME, taxpayers will lose about 19 cents in administrative costs and foregone interest. This estimate ignores the cost of default losses that may arise if borrowers are unable to repay their loans.
The province argues that these default costs are negligible because buyers must qualify for mortgage loan insurance under stringent Canada Mortgage and Housing Corporation rules, and because in recent years, default losses on such loans have been negligible. If you have read or seen The Big Short, an account of the U.S. housing crisis of the late 2000s, you have heard that one before.
Borrowers default when things go wrong, not when markets are overheated, as CMHC considers Canada overall, Vancouver and Victoria to be at the moment. Overconfidence in the U.S. housing market led to risky loans that fed home price growth and eventually led to losses to lenders and their investors.
HOME loans are second liens, which means that the province is likely to receive no repayment if the borrower defaults.
An obvious way to estimate the expected cost to taxpayers of default risk is to ask how much it would cost to transfer this risk to a third party mortgage insurer, like CMHC or Genwoth. Not surprisingly, high loan-to-value mortgages and second lien loans are more costly to insure because they are riskier.
Using available prices for mortgage insurance offered by Genworth, I calculated that insurance on a HOME loan would cost 10 to 20 per cent of the loan proceeds. That means that the costs of the HOME program are almost double what the province claims. And CMHC has increased the price since I performed that calculation.
A 20 per cent premium does not imply that 20 per cent of borrowers are likely to default. Instead, the market presumably believes that there is a real risk that a significant fraction of mortgage loans will default, and that coughing up money just when things have gone so badly that borrowers are defaulting on loans is very painful and worth a premium to avoid.
Premier Christy Clark put this well in an interview with Lynda Steele on CKNW, observing that a world in which HOME borrowers default in significant numbers would be so bad that losses in the HOME program would be the least of the province’s concerns.
Most people try to hedge risks, and thus put a premium on avoiding losses in bad states of the world. That seems like sensible precaution for a provincial government, too. A home price crash large enough to trigger substantial defaults would be bad for B.C.’s economy and make it difficult for the province to raise funds — just when government assistance would be needed most.
Tom Davidoff is an associate professor at the University of British Columbia’s Sauder School of Business. He specializes in real estate markets.