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Government Housing And Mortgages In Canada
The Government, Housing, and Mortgages 1. The Dominion Housing Act (1935)
2. The National Housing Act (1938)
3. NHA Post WWII (1944)
4. The Central Mortgage and Housing Corporation Act (1945)
5. Mortgage Insurance - The NHA (1954)
6. Current Mortgage Insurance Products
HISTORY OF FEDERAL GOVERNMENT LENDING PROGRAMMES
Prior to 1935, the federal government had undertaken only one mortgage lending program, the post- World War One involvement under the War Measures Act (P.C. 2997 (1918)). The details of this program provided that $25 million be appropriated for loans (bonds) to the provinces, to be re-lent to municipalities for the construction of residential units for sale and/or for mortgage loans to purchasers of new housing units for owner-occupancy.
The maximum loan was to be between 80 and 90% of lending value of the property or $4,500, whichever was smaller. Annual interest was charged at 5%, with 20 to 30 year contractual terms.
These mortgages were not amortized; rather interest was paid periodically and the full amount of principal was due upon maturity. The municipalities could, as well, lend to limited-dividend corporations for the purpose of constructing residential units for sale or rental. Due to conditions prevalent in the construction industry during this period (shortages of materials, price increases, etc.) and the municipalities' inexperience as mortgage administrators, the program was considered to be unsuccessful in meeting its objective (to stimulate the supply of housing). Only 6,244 units (2% of the volume, 1918-1924) were constructed under this scheme.
In the conventional market, prior to 1935, most mortgage loans were for short terms, usually five years, with no obligation on either party to renew (although such renegotiations were, subject to review of the mortgage terms, quite common). Repayment was unamortized and generally followed one of two methods:
periodic payment of accrued interest (quarterly, semi-annually or annually), with the principal becoming due and payable on maturity;
periodic payment of accrued interest plus fixed amounts of principal, the outstanding balance due at maturity.
Borrowers made their own property tax payments, producing receipts for inspection by lenders. Prevailing interest rates were in the range of 6.0 - 6.5% and most loans were made at about 50% of lending value. Institutional lenders could not lend in excess of 60% of value.
The Dominion Housing Act (1935)
The Dominion Housing Act (1935) is considered to be one of the most significant pieces of Canadian housing legislation. This is because of its effect on private mortgage lending practice and because it initiated the process of continuing federal participation in residential mortgage lending (rather than for the volume of activity carried on under the Act).
The main program introduced under this Act was joint lending by the government and institutional lenders on new houses for owner-occupancy or rental. Funds for joint mortgages were supplied by both the government and the approved institutional lenders (insurance, trust and loan companies). The approved lenders were responsible for the administration of loans. The government provided 20% of the lending value and the private lenders provided between 50 and 60% (the maximum then permitted). Loan- to-value ratios, therefore, were in the range of 70 to 80%. As the interest rate on the mortgage was set at 5% and the rate on the government's share was to be 3 %, lenders received between 5.7 % (on loans at 80 % of value) and 5.8 % (at the 70% level) interest on their investment. Loans were to have a ten year term with the provision for a ten year renewal period. Borrowers also had the right to prepay after three years (as compared to five in the conventional market) with a three months' interest payment going to the lender as compensation for releasing the mortgage prior to maturity.
The Act also introduced to Canadian mortgage practice the now standard constant payment plan (or amortization plan) where the loan is repaid by equal monthly payments of principal and interest. Also included was the concept of adding to these blended payments one-twelfth of the amount of annual real property taxes, to be placed in an account out of which taxes were paid, by the lender, when due. On-site inspection of construction and minimum construction standards were also introduced in the 1935 Act.
To provide protection for the lender's share of the loan, and thereby compensate lenders for receiving a rate of return lower than could be obtained in the conventional market, a guarantee program was included. Until the loan had been amortized to a level equal to the amount of the lender's contribution (e.g., the maximum private loan-to-value ratio), two-thirds of all losses would be borne by the government. Once this loan-to-value ratio was attained, the government would carry one-third of the amount of the loss. The 1935 Act was to be administered for the federal government by the National Housing Administration, a responsibility of the Department of Finance.
Although the actual activity carried out under this 1935 Act was relatively modest (4,899 units completed or 3% of the activity in the period 1935-1938), the terms and concepts introduced in 1935 greatly affected mortgage lending practice, both under subsequent federal programs and in the conventional mortgage market.
The National Housing Act (1938)
The next major change was the National Housing Act (1938) which replaced the Dominion Housing Act (1935). This new Act provided a restatement of the preceding legislation with one exception. The exception was a change in the proportion of each loan that was provided by the federal government on the joint mortgages. Under the 1935 Act, the government provided a fixed proportion of the lending value of each loan (and hence a variable portion of the amount of the loan actually advanced) at rates lower than those charged on the mortgage loan. For example, under the 1935 Act the federal government provided 20% of the lending value. If the private lender provided 60%, the government then contributed one-quarter of the total loan. However, if the private lender only advanced 40%, it meant the government effectively advanced one third of each loan. Lenders preferred to give lower level loans, thereby obtaining a higher return on their own funds. Under the 1938 legislation, the portion of the loan provided by the government, regardless of the level of the total loan, was set at 25 %, thereby not encouraging lenders to promote low loan-to-value loans. This change was in keeping with the other new portions of the 1938 Act introduced to assist low income families in attaining house ownership. The details of these new sections included:
Loan-to-loan value ratios of 50% to 90% for new houses of $2,500 or less in lending value. The upper limit reduced the equity requirements; and the lower limit was to permit the owner's labor on the construction of such units to be included as equity. The 70-80% range was retained for new units costing more than $2,500, to ensure that lenders would not make only low ratio loans, thus excluding persons with low equity from participation under the Act.
To encourage lending areas not adequately served by conventional lenders (e.g., small communities, rural areas), grants of funds to cover additional expenses (all travelling costs plus up to $20.00 per loan on all loans less than $4,000.00 in value) and a pool guarantee system were made available to approved lenders active in these remote areas. This system involved crediting each lender with between 7% and 25% (determined by the value of the loan and other factors) of each loan made in these areas. If a loss through default occurred on a loan, the government absorbed one- quarter of the loss and the remainder came out of the lender s total guaranteed credit. For loans made in the better served areas, the loss sharing system of the DHA was retained.
The federal government provided partial assistance, for up to three years, in the payment of real property taxes on new homes costing less than $4,000.00.
Provision was made for direct lending by the government to municipal housing authorities and limited dividend corporations wishing to construct low rental housing. Loans were to be 80 to 90% of lending value, at 1 3/4 to 2% interest per annum, with amortization periods up to 35 years. Municipalities were asked to provide property tax relief for these low-rental projects. Although no units were constructed under these provisions, they provided the basis for similar programs under subsequent legislation.
The outbreak of the Second World War resulted in a significant shift in the government's economic priorities and immediate changes in federal housing policy. These changes meant that during the war years. the use of the provisions of the National Housing Act (1938) was very restricted, as were housing and mortgage markets in general. In 1939, price and rent controls for housing were established, the National Housing Act (1938) provisions for direct lending were suspended, and, for the first time, a maximum amount of a National Housing Act loan was set (at $4,000). The Wartime Housing Corporation, established in 1941, was to produce housing units for defense workers and other persons engaged in war efforts. This production was required to accommodate the tremendous population growth in industrial and port communities.
From 1941 to 1949, the Wartime Housing Act accounted for construction of 45,930 units with a total expenditure of $253.7 million. The NHA (1938) was amended in 1943 so that the loan-to-value ratio was to be calculated according to the formula of 90% of the first $2,200 of lending value, and 80% on the remainder up to the maximum loan of $4,000. In 1944, the interest rate on NHA loans was reduced to 4.5%, giving lenders a yield of 5% on their share of the joint mortgage. From 1938 to 1944, lending activity under the NHA (1938) provisions was limited: 21,414 new units were constructed (7% of total starts).
1944 National Housing Act
A relatively low level of residential construction prior to and during the Second World War and increases in incomes, family formation and urbanization which resulted (directly or indirectly) from the war, combined to produce a situation where housing needs and desires were greatly constricted by the available stock. To deal with this problem, the Federal government passed the National Housing Act NHA (1944). The new NHA was, in principal, very similar to the preceding one as the following details of the 1944 legislation indicate:
Joint lending was retained: The amount of loan to be given was again determined by a loan to-value formula - 95% on the first $2,000.00, 85% on the next $2,000.00 and 70% on the remaining portion of lending value with the government putting up 25 %.
The term of the mortgage was set at 20 years, with borrowers having the right to prepay after three years or on any subsequent mortgage anniversary date, subject to paying a three months' interest fee to the lender. Interest rates were determined by periodic agreement between the lenders and the government. Once agreed upon, they were fixed by statute. The initial rate, and the one that prevailed until 1951, was 4.5%. Provisions were included to further encourage joint lending in remote areas. The existing guarantee systems were retained. New housing constructed on farms was eligible for loans up to $5,000 (if the title was unencumbered) and $8,000 if debt consolidation was required. All low cost housing was eligible for 90% loan-to-value ratios.
The Central Mortgage and Housing Corporation (CMHC) Act (1945)
The Central Mortgage and Housing Corporation (CMHC) Act (1945) established CMHC as a Crown Corporation to administer, on behalf of the government, the federal participation in housing as described by the NHA (1944). The Corporation, then under the Minister of Public Works, took over the powers formerly exercised by the National Housing Administration. The Corporation was to obtain its capital by advances from the Consolidated Revenue Fund in exchange for its own debentures. This capital was to provide funds for the Corporation's activities, including mortgage lending. Debenture repayments were to be made out of revenue derived from these mortgage activities. The Corporation's head office was established in Ottawa with regional offices in Halifax, Montreal, Toronto, Winnipeg and Vancouver. In each of these regions, several local offices were established.
The Corporation was authorized in 1947, for the first time, to make direct loans to home owners, or builders or developers of rental housing where joint loans were not being made available by approved lenders. This was of particular importance in rural areas and smaller communities where the lenders had shown great reluctance to invest. The term for both joint and direct loans on owner-occupied units was extended to a maximum of 25 years and to 30 years for rental units. The loan-to-value formula was increased to 95% on the first $3,000, 85% on the next $3,000 and 70% on the rest of the lending value.
In 1948, a minimum net return of 2.5% was guaranteed to developers of rental housing. Due to a rapid rise in construction costs, the loan-to-value formula was of little functional value and it was replaced by a flat 80% ratio. In addition to the joint loan of 80%, the Corporation was permitted to grant, on its own, a further 1/6 of the amount of the loan. This increased the government's actual share of loans granted from 25% to 35.7% and it placed the level of the loan at 93.3%. Provisions for federal- provincial co-operation in development of housing for sale or rental and in land assembly projects was also introduced. Finally, the maximum term for loans was set at 30 years.
A change in federal monetary policy in 1951 required that a new method of determining the interest rate under the Act be used. An amendment to the NHA established that a maximum rate was to be set periodically by an Order-in-Council, not to exceed the going yield rate on long term (12 year) Government of Canada bonds.
While the NHA (1944) was in effect, from 1944 to 1953, a substantial portion (26%) of all residential construction activity took place under the terms of the Act. Despite the expanded direct lending powers of the Corporation, most of the activity (86%) was in the form of joint loans made by approved lenders. 214,206 units were constructed and $1,379 million were advanced under the Act. The Corporation's total contribution was $496 million (36%), and relative to the amount of lending activity, losses to lenders were negligible. The amount of credit in the various guarantee pools continued to accumulate.
CURRENT FEDERAL PROGRAMMES: THE NATIONAL HOUSING ACT (1954)
The number of new units constructed from 1944-1953 was deemed to be insufficient to meet the increased demand, due partially to the low level of wartime residential construction and increased demand caused by a high rate of family formation and immigration. Under the 1944 legislation, mortgage funds came from government and selected lenders (mainly, insurance companies). These sources were not sufficient to keep pace with the demand for mortgage funds.
The overriding objective of the 1954 legislation, the National Housing Act, was to increase the supply of mortgage money available from private lenders. Another important objective, given an increased supply of mortgage funds available through the private market, was to free government funds, highly committed to joint mortgage lending under the previous acts, for the other housing concerns of the Corporation.
To bring about an increase in private funds and shift toward private lending, three major innovations were introduced with the NHA (1954). These all centered on the activities of the approved lenders;
First, joint lending was replaced by government insured loans, the full amount of which were provided by the lenders.
At the same time, the Bank Act was changed to permit chartered banks to lend on mortgages insured under the National Housing Act (1954).
Finally, provision was made to establish a secondary market for insured loans (e.g. resale market). The sale of insured loans to investors other than approved lenders would increase both the supply of mortgage funds and the liquidity of the insured loans.
The National Housing Act (1954) and its subsequent amendments contain the current legislation relating to federal participation (through the agency of CMHC) in housing and mortgage lending. The following sections discuss those aspects of the legislation which are directly relevant to current practice. Each section describes the general contents of the portion of the Act under consideration, the initial specifications of these portions and any subsequent changes to the date of preparation of this book that are of particular importance. Readers are advised that the terms of federal involvement are contained either in the Act itself or in the National Housing Act Loan Regulations, depending on the specific aspect. Both of these sources, as well as the Approved Lender's Handbook (available from CMHC), should be consulted for detailed current information about the procedures and regulations regarding federal involvement in mortgage lending.
Under the old joint lending programs, the government provided a significant portion of the money advanced to borrowers. It also granted a number of subsidies to both lenders and borrowers. Government funds were provided to lenders at a rate below the rate they received on the entire loan and protection against losses and appraisal services were provided free of charge. The 1954 legislation provides that the approved lender advances the full amount of the loan under the protection of a government mortgage insurance policy. This means that lenders can grant higher loan-to-value ratios and remain protected against loss by an insurance fund created and funded by the borrower's payment of an insurance fee. The borrower is required to pay an application fee to CMHC to partially defray the costs of inspection and appraisal services. Both application and insurance fees are remitted to the Corporation by the lender, who is fully responsible for the administration of the mortgage loan.
The Corporation acts only as the insurer; and it is as such that it carries out property appraisal, determination of lending value and construction inspection. The following discussion of the practice of mortgage lending by approved lenders moves through the stages of the general procedure. As the role of the approved lender in administration of NHA-insured loans is essentially the same as was outlined for the conventional lender, only those procedures and terms unique to the Act will be emphasized.
A. Lending Practice
Lending activity commences with the submission of an application for a loan to one of the approved lenders. Lenders cannot normally make a loan which is more than 75 % of the market value of any house unless the loan is insured by the CMHC or another mortgage loan insurance company. With CMHC, mortgage loan insurance may be available for loans up to 90% of the house value, 95% through the FHLI program. Initially, the following were eligible to receive these NHA insured loans:
for new units, the construction of which must not have proceeded beyond the excavation stage prior to approval of the loan;
the owner-occupant of a house or duplex, the builder of a house or duplex for owner occupancy, the developer/builder of rental housing projects, co- operative housing groups;
the purchaser of an existing residential structure, if one or more new additional units are to be created by physical alterations (i.e., converted multi-family).
Under all preceding legislation, the emphasis had been on new units. The extension of eligibility to include some existing units as above marked the first step to lending activity oriented to existing stock. It was not until 1966 that purchasers of existing units for owner-occupancy were made eligible for insured loans. These units were to be brought up to CMHC established minimum housing standards by an expenditure of not less than $1,000 within one year after the granting of the loan. In 1969, the requirement of construction on existing houses obtaining insured mortgages was dropped and all existing houses became eligible.
The CMHC requires that builders of new homes, for which mortgage loan insurance is being sought, be registered in a new home warranty program and that the house is enrolled in this warranty program (e.g. The New Home Warranty Program of British Columbia and the Yukon or National Home Warranty Canada). There are seven such programs across the country which require builders to apply to become members, showing they have adequate technical qualifications and financial resources.
The chartered banks and Quebec saving banks, as well as insurance, loan, credit union and trust companies, were (and continue to be) approved lenders under the Act. Prior to 1954, the chartered banks were not permitted to undertake any mortgage lending activity, and the Quebec savings banks had only limited mortgage lending powers. Presently, both of these have the same lending status as the traditional approved lenders. Not only did this increase the supply of mortgage funds available under the insured mortgage programs but, because of the local branch concept in the Canadian banking system, insured loans became available almost everywhere in Canada even in smaller communities, rural and remote areas (where lenders had previously shown great hesitancy to lend). To avoid duplication of effort the CMHC takes a secondary role in inspection and appraisal, allowing the services provided by municipalities to be used in the application process. However, in areas where inspection and appraisal services are unavailable, the CMHC will carry out the necessary review and be responsible for providing progress advance examinations for a higher application fee. Thus, lenders are not required to employ an appraisal staff in order to participate. Although the banks made a substantial portion of the NHA-insured loans in the early years of the Act, the interest rate on these loans, by 1959, had climbed above 6%, the maximum rate that banks could charge under the Bank Act. From 1959, the involvement of the banks was almost negligible until 1967, when the Bank Act was amended to remove this interest rate constraint. At the same time, the banks were permitted to participate in conventional, as well as NHA- insured, mortgage markets.
If an approved lender accepts the initial application, it then proceeds with the detailed credit analysis, working with an estimate of the lending value of the property. If unable to determine a sufficiently accurate estimate of value for these preliminary purposes, the lender may ask CMHC to quote estimates of the lending value and the amount of the loan that the Corporation is prepared to insure. The lender may then consider this amount, or a lower one, as its estimate. If, after the results of these investigations have been examined, the lender is willing to make the loan, it then forwards to CMHC a "Request to Undertake Insurance" form which lists all of the details pertinent to the loan.
After the Corporation has examined these documents and determined the lending value, it decides whether or not it is willing to insure the loan. If it is willing, it will send back to the lender its "Notice of Undertaking to Insure", a document stating the Corporation's commitment to provide insurance. At this point, the lender will, after further discussion with the applicant, decide whether or not it will make the loan. If the decision is positive, the mortgage document is prepared. The mortgage document is very similar to that used in the conventional market, save that it is subject to certain maximums and specifics prescribed by the Act and the Regulations. Thus, it is necessary to consider the financial and other aspects of the mortgage document.
The amount of loan is determined by a loan-to-value formula. The one time insurance fee charged by CMHC varies according to the loan to value ratio and reflects the relative risk of the loan. The other constraint is the borrowers ability to carry the debt financing based on their gross income and other debt obligations. CMHC will only allow a borrower to spend 32% of their gross income on shelter obligations, Principal Interest Property Taxes 1/2 of the Condo Fees and Heating Costs, and no more than a total of 40% on this shelter and non shelter financial obligations combined. The result is that a borrowers maximum monthly mortgage payment is derived and from this the maximum loan is calculated using the current market interest rates for the prescribed mortgage term structure. As such the level of prevailing interest rates in the market has a large impact on the maximum mortgage amount and the maximum affordable home of the borrower.
Under the initial terms of the 1954 legislation, borrowers had the right to a minimum of a 25 year term and amortization period which, with the consent of the lender, could be extended to 30 years. In 1969, the lending regulations were changed to permit renegotiations of mortgage agreements during the life of the debt as an alternative to fixed interest rate mortgages (e.g., five year call option or term). In 1980, new construction and existing housing for homeownership, rental and co-operative housing qualify for this arrangement where lenders may write mortgages having a term of 5 years and a maximum amortization period of 30 years for home-ownership housing and 35 years for rental housing. Currently, more than 90% of NHA-insured loans are of this type. In certain cases, amortization periods of 40 years may be granted.
The maximum gross debt service ratio in 1987 was 32% for owner-occupied single family units, and 42 % for owner-occupied duplex units. In the 1954 Act, income used to determine the gross debt service ratio was defined as "the husband's annual income plus one-half of the wife's annual income plus the annual amount of any other regular income (including rental on the other half of duplex structures)". Since 1972, the regulations provided that either the husband or the wife may be considered the home- owner or home-purchaser, the choice being the prerogative of the borrower. Also, the gross income is calculated on the basis of the amount of the purchaser's income plus the amount of the purchaser's spouse's income plus any other income (includes investment income). Parenthetically, the Act prohibits discrimination against any person for reasons of race, color, religion, place of origin, sex or marital status.
Under the 1954 Act, the interest rate was originally established periodically by the Governor-in-Council in such a manner that the rate at the time of prescription was not to exceed the 20-year government bond rate by more than 2.25%. This statutory setting of a maximum rate contrasted with the previous practice of the specific rate being set and fixed by negotiation between the Corporation and the lenders. When the conventional rate for mortgages exceeded that allowed under the Act, lenders restricted their activities with respect to government insured loans. The Act was amended in 1969 and rates on mortgages given under the Act were freed to find their own level, allowing approved lenders to obtain competitive yields on these investments.
Non-Financial Aspects
The non-financial aspects of mortgage agreements under the Act are almost identical to those of conventional loans made by institutional lenders. Real property taxes can be paid to the lenders, rather than the borrower being responsible for direct payment to the appropriate local government.
Private Mortgage Insurers
Once the mortgage document has been drawn up according to these specifications, it is signed by the borrower, the charge against the property is registered and CMHC is advised by the lender's submission of a completed "Advice of Loan Approval or Withdrawal of Application" form. Since 1961, lenders have been required to obtain evidence that home owners and purchasers are providing from their own resources (either cash, labor or land) equity to the amount of 5% of the lending value. In 1983, the minimum equity was increased to 10% of lending value, and remains at this level except for first time home buyers qualifying under the FHLI program.
Mortgage loan insurance was pioneered in Canada in 1954 by CMHC. The basic framework of principles and policies that CMHC developed for mortgage loan insurance is still in use today by both CMHC and private insurers. The Mortgage Insurance Company of Canada (MICC) entered the market in 1963. In 1973 the industry expanded with the formation of two other companies which merged in 1978 to form the Insmor Mortgage Insurance Company. In October 1981, MICC and Insmor merged retaining the MICC name. MICC is now a part of the General Electric family of companies.
