Government Proposes Changes to Mortgages that Create Moral Hazard
The Financial Consumer Agency of Canada (FCAC) has proposed changes to mortgage rules directing banks to waive costs for distressed mortgage holders that create moral hazard and an injustice to financially prudent Canadians who:
Bought smaller homes in order to avoid the financial risks of a larger mortgage if interest rates were to rise.
Chose to continue renting because they were uncomfortable committing to a very large mortgage.
The proposed FCAC guidelines instruct Banks and Lenders to waive mortgage penalties, fees, and interest payments if a borrower experiences financial hardship. While this is compassionate it creates a moral hazard:
Canadian borrowers who overextend themselves (i.e., taking on more debt than they can handle at higher mortgage rates), are rewarded with larger homes, waived penalties, fees, and mortgage interest costs.
Canadians who take on less risk buy smaller homes or rent.
Going forward, the government encourages Canadians to take on more and more risk because whenever risks turn into critical issues, the government bails out the distressed borrowers.
A real concern is that if all Canadians begin to take on risks that are too great for them to handle, eventually the risks taken on my homeowners might becomes too costly or too destabilizing for the financial system and cause a crisis like the one that occurred in the U.S. in 2007/08.
More importantly, this system is rewarding the risk-taking Canadians who create a financial risks for themselves and the government, thereby penalising the responsible Canadians who are also paying taxes and helping to bail out the risky ones.
This is a classic example of moral hazard. Moral hazard occurs when people take on more risk because they know that they will be protected from the consequences of their actions. In this case, borrowers would be more likely to take on more debt because they know that they will be able to get out of their payments if they run into trouble.
The proposed changes would also be an injustice to Canadians who are renting and do not benefit from the waived penalties, fees, and interest payments, even though they may be struggling financially.
The FCAC should reconsider these proposed changes because:
They create a moral hazard encouraging risk-taking in real estate.
They benefit overextended homeowners at the expense of prudent homeowners and renters.
Here are some additional thoughts on the proposed changes:
To ensure consumers are fully aware of their risks. Mandate that mortgage applicant should have a scenario analysis prepared for them that shows them the monthly costs of potential higher rates (i.e., the worst case scenario), ideally prepared by a Wealth Advisor who has no financial interest in the home purchase.
Create guidelines that help distressed owners shoulder the costs of higher mortgage rates (e.g., extending the duration/amortization of the mortgage, refinancing to pay off interest arrears)
The worst case scenario, in most cases, is a homeowner sells their home which has appreciated significantly in value and repays the mortgage in full.
A possible suggestion is that these bailouts should only be available to Canadian households who earn the median Canadian income (i.e., $73,000) or less.
The proposed changes should be carefully considered before they are implemented. As presented today, the proposed guidelines will increase Canadian inequality, reward risky behaviour, and place the costs of those bailouts on the rest of Canadians.
