Death of 40-year mortgage!

When Canada Mortgage and Housing Corp. (CMHC) recently announced it was no longer backing 40-year amortization mortgages, it presumably was attempting to put some order into the teetering housing and mortgage markets. In the process it quashed the hopes and dreams of thousands of Canadian entrepreneurs who had rallied to the new mortgage as a flexible method of financing small businesses.

The 40-year mortgage was initiated by lenders last year as home prices climbed to levels that put monthly payments out of reach for many homebuyers. The theory was that by extending mortgage periods up to 40 years from 25 years, lenders could keep monthly payments lower. This, when coupled with low down-payment requirements – usually about 5% – would keep more people in the mortgage market. But there was more risk involved, so they also required the mortgages be insured by CMHC. When that body removed its backing, it essentially killed the plan.

Many financial advisors detested the 40-year mortgage because the numbers involved were almost pornographic: Math showed it would triple the cost of a home if extended for the entire 40 years. They contended the new mortgage would draw the most marginal of homebuyers into the market, setting the system up for much grief if the economy wobbled. And when the U. S. subprime mortgage mess created an avalanche of foreclosure horrors, their visions became the conventional thinking.

However, many Canadians who flocked to the mortgage — about 40% of new mortgages last year were of the 40-year variety — weren’t the marginal homebuyers feared by economy watchers. They were entrepreneurs who had been hamstrung for years by the small business lending market and saw it as a flexible method for financing their businesses.

In Canada, about 56% of 2.2 million “employer businesses” employ one to four workers, commonly called micro businesses. About 2.5 million Canadians identify themselves as self-employed, and many of these people are treated as pariahs by a lending system that operates on a dependable repayment schedule, and so almost always ties a mortgage to a steady job. In contrast, self employed and micro business operators generally have variable incomes that are out of sync with the 9-to-5 world preferred by most bankers.

Previously, micro business operators were usually given the bum’s rush by lenders, and were either forced to go to the private market, or bring in tax returns to show they had dependable income. The latter works against proper business tax planning, which involves trying to get your personal income as low as possible.

As an example of this kind of convoluted lender thinking, I recall a situation where a Toronto couple who owned a successful business applied for a mortgage, and the husband who was listed as the owner was rejected because he was self-employed. But the wife was approved because she was employed by the business.

Any entrepreneur can tell you that small business operation continually has its revenue highs and lows. The 40-year mortgage was perfect for very small business operators because it aligned with their income patterns. Also, its flexibility allowed the homebuyer to make a low mortgage commitment that could be covered in lean times, but also allowed them to slap extra money on that mortgage when revenues were fatter. It also helped them to own an asset that could then be used to get a line of credit that micro business operators often use for operating capital.

By killing the 40-year mortgage, the CMHC and lenders were trying to protect Canadians from overextending themselves. Canadian authorities, it seems, are always quite willing to protect us from ourselves, especially when it comes to our ability to pay back their loans.

Yes, the 40-year mortgage was riskier for lenders than a conventional mortgage. But most entrepreneurs live with risk every day and have learned how to handle it. It’s often feast one month and famine the next, so they operate on a form of budgeting based on worst-case scenarios and treat everything above that as a bonus. By looking simply at the math, and not at the usage patterns or the primary buyers of these mortgages, lenders laid waste to one of the few financing methods in existence for this growing army of 21st-century small business operators.

— – Tony Wanless of Knowpreneur Consultants (www.knowpreneur.net), is a Certified Management Consultant who helps knowledge-based businesses with strategy, innovation and planning.