A zero-down mortgage by any other name?

LORI MCLEOD

Globe and Mail Update

July 31, 2008 at 7:49 AM EDT

As the financial industry sits down with Ottawa this week to assess tighter mortgage rules, another lending product could find its way into the spotlight – cash-back mortgages.

Keen to avoid a U.S.-style housing bubble, the federal government recently cracked down on lenders and insurers through a series of reforms. Major changes already announced include a planned withdrawal of government guarantees for mortgage loans where the down payment is less than 5 per cent of the home’s value, and for those with amortizations of more than 35 years.

Yet while lenders are phasing out so-called zero-down mortgages, many are still offering buyers a similar option through the use of cash-back incentives in lieu of a down payment. This practice will be up for discussion this week, said Finance Department spokesman Jack Aubry.

Cash-back mortgages could be more contentious if lenders start using them to attract leveraged home buyers who otherwise cannot afford to buy – filling a void created with the loss of zero-down-payment.

This week, Toronto-Dominion Bank rebranded its No Down Payment Mortgage as the CashBack Down Payment Mortgage.

In an e-mail to brokers, TD Canada Trust said the product’s terms and conditions hadn’t changed.

Canada Mortgage and Housing Corp. (CMHC) has also said it will continue to offer a similar product, CMHC Flex Down. In fact, most major lenders have some type of cash-back or “flexible” down payment mortgage option.

In essence, the products aren’t much different than a 100-per-cent mortgage loan. The difference is that they allow buyers 95-per-cent financing through their mortgage, and the remaining 5 per cent down is paid by the bank in exchange for the borrower taking on a much higher rate. That’s usually the posted mortgage rate instead of the discounted rate available to most home buyers, which can mean a cost difference of 1.5 percentage points.

Since the mortgage loan itself meets the new 95-per-cent loan-to-value maximum, all but the 5 per cent in funds borrowed for the down payment is eligible for government backing, which protects the lender against the risk of default by the home buyer, Mr. Aubry said.

Cash-back products were available before the government changes and aren’t a new product emerging to fill a niche, said Joan Dal Bianco, vice-president of real estate secured lending at TD Canada Trust.

In fact, with more clarity from the government regarding the changes, which also include new credit score requirements and loan documentation standards, TD Canada Trust will reassess the CashBack Down Payment product to decide whether it is still appropriate, Ms. Dal Bianco added.

“For this particular product, I will be revisiting whether we keep it in the market or not once we have clarified things. We may pull this particular one, where it goes to the lawyer specifically for the down payment …”

Mortgage broker John Panagakos said he plans to steer his clients clear of cash-back mortgages.

The monthly payments and interest costs are higher than those of traditional mortgages in the early years, meaning little financial flexibility for stretched buyers, he said.

Instead, it’s worth it to wait and save the down payment or borrow it from a family member, he added.

“To me, this basically looks like no money down, but wearing a new suit,” Mr. Panagakos said.

Here is my take on this. Currently you can qualify for 100% financing with a 680 or higher beacon score amortize it over 40 years and also get a discounted rate of around 5.65%. However with the new rules your rate will be 7.15% and you are limited to 35 years. Say you buy a house for 200K with the current program your carrying costs will be 1,043.08 per month and with the new financing rules your carrying costs will be 1,284.14 per month. This adds 241.06 more per month to your debt service load. Sure you pay more in interest over the life of the loan, but if the consumer does not feel it over a monthly basis then what is the risk. Anyway options will still be available to consumers with good credit who want zero down, they just will have to pay out more to exercise those options. Thanks but no thanks!

Cheers,

Pat