Home sweet home

Long-overdue changes are coming to Canada's hidebound mortgage-insurance business.

Self-employed? Just out of college? Stuck with an embarrassing bankruptcy in your past? Don't worry. Andy Charles wants to help you buy a house. And get this: he doesn't even care if you know who he works for.

Charles is the president and CEO of AIG United Guaranty Mortgage Insurance Company Canada. It's a long name for a company most people will never remember. But just the prospect of the firm's entrance into the once sleepy mortgage-insurance industry has made it easier for thousands of Canadians to get their own home.

By law, all Canadian homebuyers who have less than a 25% down payment for their new house have to buy mortgage insurance. This mandatory insurance protects the lender in case the borrower defaults on mortgage payments. If the bank, credit union or other mortgage provider is forced to foreclose on the house and loses money on the resulting sale, mortgage insurance covers the difference. Mortgage insurance thus turns high-risk borrowers into no-risk borrowers.

With nearly half of all Canadian homebuyers requiring mortgage insurance, it's an important — and lucrative — line of business. Canada Mortgage and Housing Corp., a Crown corporation dating back to 1946, has long dominated the market and currently holds a 71% share. Private-sector insurer Genworth Financial Canada has, since its arrival in 1995, been the lone competitor to CMHC. The two firms have operated as a cosy duopoly for the past decade, charging identical rates and racking up enormous sums. Last year, for instance, CMHC made $1-billion profit selling mortgage insurance to Canadians.

Naturally enough, such profits have signalled there is money to be made in the mortgage insurance business. And the prospect of new competition has already been good for Canadian homebuyers. In 2004, North Carolina-based AIG United Guaranty, or AIGUG, made its first inquiries about entering the Canadian market. The next year, CMHC and Genworth both announced identical rate cuts of 15% on their premiums. And since March, when it became obvious Andy Charles would be setting up shop here later this year, a flood of new products and price cuts has appeared. In addition to the traditional 25-year mortgage, it is now possible to obtain a 30- or 35-year mortgage with insurance from CMHC or Genworth. Application fees have been dropped and interest-only and no-down-payment options have also been announced.

“We have seen more innovation in mortgage insurance in Canada in the last six months than in the previous five years,” notes Charles, wryly. “The existing players have certainly anticipated our arrival and become more innovative. But with the Canadian market insuring $50 billion to $55 billion [worth of] mortgages a year, we feel there are lots of opportunities.” In fact, Canada is the second-largest mortgage-default insurance market in the world, after the United States. AIGUG recently passed requirements set by the Office of the Superintendent of Financial Institutions and is now in the final stages of approval. Charles expects to be writing his first policy shortly.

One complication for AIGUG's entry into the rich Canadian market is that Ottawa will soon be changing the rules on mortgage insurance. The federal department of finance has announced that the 25% down-payment limit is likely to be lowered to 20% by next summer. “This will obviously reduce the size of the market for us,” admits Charles, who figures about 6-8% of homebuyers will no longer need mortgage insurance if the down-payment requirement is changed. “So our challenge is to expand the market on the other end and find our niches. We want to get more Canadians into their own homes.”

A further difficulty for Charles and other potential competitors is that most homebuyers have little scope in selecting who insures their mortgages. Charles's real customers are the lenders themselves, who typically choose the insurer for each buyer. If AIGUG wants to shatter the current duopoly, it will have to align itself with an underserved segment of the lending business.

Currently, the big banks control approximately two-thirds of the mortgage business. Credit unions and specialty mortgage lenders have another quarter. What's left is the small but fast-growing sub-prime market, which has Charles's eye.

Sub-prime lenders serve borrowers who don't fit into standard underwriting categories because they are considered higher risk. “We are going to look at insuring self-employed individuals, people earning commissions, new arrivals to this country and people who, for whatever reason, had a credit blemish in their background,” Charles says. This means he is prepared to be more forgiving in terms of past credit problems, will accept income volatility among the self-employed, and will ease onerous requirements to produce bank records from other countries when it comes to writing mortgage insurance policies for immigrants.

Lenders who want to offer reduced down-payment mortgages will also get lots of attention from AIGUG. Currently, CMHC will insure a 5%-down mortgage and allow the homebuyer to borrow the required down payment elsewhere. Once Charles opens up shop, he says he's prepared to lower the down-payment requirements even further, and ultimately plans on “a real zero-down product” with no money required upfront at all. And he doesn't blink at the thought of pushing amortization limits to 40 or even 50 years. “A longer amoritization period allows for lower monthly payments, which means you can enter the home ownership market sooner,” he says. “As circumstances change, a homebuyer always has the opportunity to make lump-sum payments, change to different terms or accelerate payments.” Charles — a former mortgage executive at CIBC, HLC Home Loans Canada and President's Choice Financial — figures that most who take on a multi-decade mortgage will pay it off much sooner than that.

Following close behind AIGUG will be two other U.S.-based companies in the mortgage-insurance business; PMI Group Inc. and Triad Guaranty Inc. are both expected to win regulatory approval in 2007 and spur even more competition. For a country that has long considered a plain vanilla 25-year mortgage from a bank to be the foundation of the home-buying industry, the potential changes wrought by these new entrants and product innovations strike some observers as puzzling, and perhaps dangerous.

Credit counsellors, in particular, fret that luring renters to sign up for mortgages based on lengthy amortization periods and/or no-money-down deals during a national real estate boom could lead to a rash of foreclosures when the market eventually turns south. “A 35-year or longer mortgage encourages people to take on more debt than they can really afford,” says Debbie Klein, a manager with Credit Counselling Services of Alberta Ltd. More than half of the clients who come to her organization's offices for debt counselling are already homeowners. “A zero-down payment will mean even less saving on the part of consumers,” notes Klein. Forcing people to save teaches important lessons about household budgeting and finance, she adds. “Now there is no reason to save for anything. But consumers need to look to the future when things might not be as rosy as they are now.”

Derek Holt, assistant chief economist with the RBC Financial Group, takes a more sanguine approach. He sees longer amortization periods, no-money-down deals and interest-only payments as welcome signs that Canada's conservative financial markets are finally growing up.

Holt cites a range of exotic mortgage options that have been long available in other countries as proof that Canada is behind the curve. In Belgium, for instance, homeowners can get an “accordion” adjustable-rate mortgage: as the interest rate changes, monthly payments remain fixed but the length of the mortgage changes. Spain is well-known for its sophisticated mortgage industry. And the United States has seven private-sector mortgage insurers aggressively competing and innovating. “We have some catching up to do if we're going to match the variety of mortgage products that have been available in other countries over the past few years,” says Holt. He adds that it is a mistake to interpret all these recent innovations as a sign of late-cycle improvidence in the real estate market. While no-money-down mortgages may not be for everyone, he says, greater choice means satisfying more homebuyers.

If there is an ultimate consequence of all these changes to the mortgage business, it may be that the federal government gets out of the mortgage insurance sector altogether. While CMHC's dominant role selling mortgage insurance may have been a necessity 60 years ago, the expected flood of new private-sector competitors suggests that time has passed. “Do we really need a public-sector presence in this market anymore?” asks Holt, rhetorically. If Ottawa is still keen to help the housing market, he suggests it would make more sense to sell the Crown corporation and use the proceeds to reduce capital gains taxation or housing development charges. Then the private sector could take over full responsibility for getting Canadians into new homes. Sweet.