Many Canadians are becoming increasingly concerned about the shock of payment at renewal caused by shorter mortgage terms. Some have questioned whether longer mortgage terms similar to those used in the United States would offer greater financial stability.
Although Canadian lenders theoretically offer 15-year, 20-year, 25-year, and even 30-year mortgages, the market reality and consumer preferences present significant challenges.
Ben Rabidoux, founder of Edge Realty Analytics in Toronto explained that the Bank Act limits the amount banks can charge as prepayment penalties for breaking a mortgage.
He continued, “There is a huge amount of risk in granting someone a mortgage for 30 years and having them pay it off later.” The banks say that they will never offer 30-year loans if there is no guarantee that the borrower can stay in that range. ‘”
The issue at hand is of particular importance. Mortgages outstanding account for 76% Mortgage delinquencies are likely to increase in Canada as a result of the payment shocks associated with mortgage renewals.
If interest rates do not change, then the average payment for mortgage borrowers will increase by over 30%. fixed-payment variable-rate Rabidoux estimates that the payments of borrowers will increase by 60%.
Commonly used terms that are longer
Canadians used to have a wider range of options for payment terms. Bruno Valko recalls an era when there were more options available from lenders.
When I was the VP of Sales at First Line Mortgages we had a 15-year, an 18-year and a 25 year mortgage. [fixed-rate terms] He told CMT that the devices were available in early 2000 and they sold a few, but not a lot. Now, I think there are no more than 10 lenders.
The mortgage market in the United States is different. American homebuyers can lock in their rate and pay it off early with no penalties.
Who cares if they’re open? The IRD is not in place [interest rate differential] Valko adds that there are open mortgages available in Canada but they come with a substantial rate premium. You’ll pay an enormous amount more interest. Many people decide not to.
Valko also says that, as the Bank of Canada makes decisions about interest rates, more Canadians are finding their financial security shaped. Many of them wonder whether there is a better solution, one which allows consumers to lock in their rate for a longer period of time.
Peter Routledge of the Office of the Superintendent of Financial Institutions, OSFI’s head at the time of the recent Parliamentary hearing said: “They could do it now. It is just the price that makes it expensive.” Finance Committee Hearing. In aggregate, this would mean a net gain for the system, as it allows mortgagors to better manage their financial risk.
Canadian Mortgages are tied to U.S. Rates
According to Valko the biggest irony of our system is that Canadian mortgage rate are more dependent on American economic than domestic market. Yet Canadians experience these shocks much more.
He says that the Bank of Canada Interest rates are set based on the Government of Canada 5-year Bond Yield, historically closely linked to the U.S. 10-year Treasury Bond, which in turn is influenced by U.S. Economic indicators such as inflation and unemployment.
He says, “It does not matter what happens to Canada. What matters is what occurs in the U.S.”
Valko wonders, “If we’re so dependent on the U.S. for our mortgage rates, then why don’t we have a mortgage program that is similar?” It would be logical for our mortgage programs to align more closely with the countries that influence our mortgage rates.
What would Canadians do if they had to pay longer terms on their mortgages?
Valko claims that, although it is not currently financially viable for many banks, a shift away from the current 5-year standard could allow Canadians greater financial stability and the Bank of Canada to play a less important role in the daily lives of Canadians.
He says that the consumer can benefit from a number of things, especially if they do not want to sell. They don’t need to worry about any payment changes or a possible renewal.
Valko also warns, that since Canadian household finances, through their mortgages, and other loans products, are closely linked to interest rates, the Bank of Canada has greater control over monetary policy, which is its main tool for combating inflation.
In the U.S. you can argue that [the Federal Reserve] The sky is the limit [when raising interest rates] Because the effect is less, it does not impact many of their mortgages,” says he. He adds that this is why Canada was able to lower its interest rate earlier than its southern neighbor.
Perhaps the most compelling argument for keeping things the same was probably 2007-2008 Financial Crisis.
Valko claims that “we were among the best countries in the world when it came to being able weather the subprime crisis.” Our system was strong and able to withstand the subprime mortgage crisis, while other countries were not as strong.
Routledge, OSFI’s Routledge, made the same observation when he appeared before the Parliamentary Finance Committee. He said that many central banks around the globe are “envious” of our system of mortgage credit.
Every country’s system of mortgage is an expression of the history and regulatory policies. “I would like to start off by stating that Canada’s system of mortgages has been quite successful,” said he.
The appeal of longer-term interest rates to Canadians
The Bank Act may keep longer-term mortgages at higher prices, but Canadians might be willing to pay this premium in order to lock rates into place for a longer period of time, especially given the recent fluctuations in interest rates.
Valko has seen this happen before. He says that the interest rates were high in the 1990s, but they plummeted after the crash of 2001.
People back then experienced 7.25% [mortgage rates on a 5-year term] “People were waiting for so long, then, when they saw 10-year mortgage rates at, say, 5% and thought, wow, this is a lot lower than the 7 and 1/4 5-year rate that was offered last year,” he says. If people were to look at mortgage rates of 5% today, they would say: [once rates drop further] “If the 10-year was offered for four and a half, I would think that people might be more inclined to accept it.”
Less than 5% Canadian mortgage holders have 10-year terms due to higher rates of interest associated with long-term mortgages and the likelihood that they will break the mortgage before the term is up, resulting in significant prepayment penalties.
Rabidoux mentioned earlier that these penalties can be severe, particularly if you break your mortgage within the first 5 years.
He does believe that Canada eventually will adopt longer term contracts similar to the ones available in the U.S.
He said, “I think it’s a great idea.” I think that it will happen, but probably not for a couple of years.