Fighting a losing battle? Skip a payment.

Perma-bulls in the real estate world often use snippets of anecdotes to counter the data-driven arguments of the real estate bears who say current price levels are not supported by fundamentals.

One of the key points the bulls often fixate on is usually expressed in the form of a question with a barely passable answer attached:

"If Canadians are so stretched financially and can barely afford their homes, why aren't mortgage arrears showing up higher than they are? After all mortgage arrears are still lower than they were in the early 1990s and our Canadian financial institutions are prudent."

It's this kind of rhetoric that makes the real-estate-always-goes-up crowd breathe heavy on their finger nails before polishing them against their designer shirts in gleeful gloat mode because at this point, in their own minds, they've won the argument.  

"It doesn't matter what your data tells you, my data tells me this time it's different. And that's a fact."

Unfortunately, and you knew this was coming, that "data" provided as the bull's argument knock out punch, ignores the financial reality: it's only through mortgage product innovation that mortgage arrears aren't at record highs, despite the fact they're already double what they were just a few short years ago:

From 2006-2008, it was the 40 year amortization that allowed more over-extended Canadians to avoid falling behind. The government eliminated new origination's of 40 year mortgages in October 2008, but the banks found a way to allow the effects of them to continue: can't afford the increase in payments? Skip one. Every year. For as long as your term allows.

In 2010, the mortgage market was tightened ever so slightly by requiring CMHC-insured mortgages to be qualified at the discounted five year rate. You qualify for slightly less money, but you still have the flexibility of the 35 year amortization at the discounted variable rate to over-extend yourself into real estate financial Armageddon. The "prudent" banks are only too happy to oblige you because your mortgage is insured by the CMHC and they're turning around and selling these loans into the mortgage backed securities market faster than they're writing them anyway. In other words, the banks have zero risk in this game.  

In 2011, just 20 short days away from today, the CMHC will stop insuring 35 year amortized loans. The banks have already found their solution to this little issue, it's been working for them for a few years now: let Canadians skip a payment and roll the interest back into the principle. It's a little accounting trick that nets the debt holder more money as long as the mortgage doesn't default--Sh&t it's as close to a win-win-win as the Canadian mortgage game can generate: debtors don't have to pay their debts on time, banks don't have to default on the loans and the pension funds that eat up the MBSs being sold by the CMHC don't see any risk to their investments as long as the tax payers keep backstopping this prudent smoke and mirrors financial practice.

This skip-a-payment thing is offered by almost everyone in the mortgage game. If a household exercises this option once a year, as most mortgage contracts allow them to do, for a full five year term, it has the same effect on lowering payments as a five year extended amortization. So yeah, the 40 year amortization still exists. After March 18, 2011, the 35 year amortization will still exist. Just not in name. Case in point:

Current mortgage payment: $1500
Skip-a-payment proceeds: $1500
New "effective" mortgage payment: $1375

30 year amortization of $310,000 mortgage at 4.2%: $1500
35 year amortization of $310,000 mortgage at 4.2%: $1400

The more I become aware of what the banks do, precisely because there are few economic consequences to them thanks to Mr and Mrs Canadian taxpayer, the more I believe there is only one solution to this problem: privatize the CMHC. Prudent Canadian financial institutions my a$$.