Maybe you’ve read news articles of mortgage amortizations soaring to 60, 70 or even 90 years for homeowners with variable-rate mortgages. They paint a bleak picture of Canadians mired in mortgage debt for the rest of their lives.
Yet, in my years covering the mortgage scene, rarely has a topic been so overhyped.
Canada does not have an amortization crisis. And that’s true for one simple reason: All these lengthy amortizations you hear about are temporary.
Here’s how it works
Consider a case where you have a variable-rate mortgage with a fixed payment. (More than three in four floating – rate mortgages have fixed payments, while the remainder have payments that are adjusted up and down in line with rate changes).
With fixed payments, when rates go up, less of each payment goes toward the principal and more goes to cover the interest. Eventually, if rates surge enough, your payment at some lenders might not even cover the interest due.
On paper, as the share of payments going to the principal declines, it makes it seem like it’ll take far longer to pay off your mortgage – longer than the 25 or 30 years you originally signed up for, that is.
But here’s the thing. For people in this position, when their term is over, the lender will want to limit its risk. The lender will adjust the borrower’s payments to return them to their original amortization schedule and ensure they pay off the mortgage on time.
As a result, unless rates fall materially or the borrower refinances, most folks with temporary amortizations over 30 years will see their payment raised at renewal.
So, no. The overwhelming majority of Canadians won’t be left with a lifelong mortgage.
But that doesn’t mean people aren’t scared. Nor does it mean they shouldn’t prepare for the possibility of even higher rates.
“When I talk to my variable-rate clients, probably 80 to 90 per cent have anxiety about rates and their renewal,” says mortgage broker Niki Cuthbert of Ask Niki Mortgages Ltd. “Only 10 to 20 per cent are like those stock market guys who say they’re just going to ride it out.”
The real risks
Statistically, the actual number of people who’d take 40-plus years to pay off their mortgage is so small as to be irrelevant. According to data from Mortgage Professionals Canada, the typical Canadian pays off their mortgage in roughly half of that.
For those who want to worry about something mortgage-related, here are three more relevant risks:
#1 – Renewal payments
Odds are good that rates will be lower in the next few years. But there’s still a chance a lot of borrowers will have an unpleasant surprise at renewal.
Take someone who got a variable-rate mortgage with a 25-year amortization and fixed payments in 2021. If that mortgage matured in 2026, and rates stayed the same, they might see their mortgage payment jump by more than 10 per cent.
A small minority won’t be able to handle even a 10-per-cent payment jump. But that’s not going to cause a systemwide catastrophe for at least three reasons: (1) overall incomes will rise over five years, (2) most banks have distressed borrower programs – some allow 35- to 40-year amortizations on exception, and (3) other refinance options exist for those with 20 per cent or more equity.
#2 – Housing selloff
Many cash-flow-challenged borrowers can refinance to extend their amortization. Some will even go with an interest-only, non-prime lender that doesn’t stress-test the mortgage.
The trick, among other things, is that they need at least 20 per cent equity.
“In markets like the Greater Vancouver Area, most properties appreciate over five-year spans, and few people are putting down less than 20 per cent,” Ms. Cuthbert says. “Many who need to extend to a 30-year amortization can do so because their equity has grown.”
In fact, 82 per cent of mortgages start with at least 20 per cent equity (the down payment), according to Bank of Canada data. And most folks have significantly more than that. Hence, if home prices go downhill, only a minority of homeowners won’t have the equity they need to refinance.
Unfortunately, the only option for some folks with no way to restructure their borrowing will be selling. Couple that with recession-triggered job losses, and we could see supply hit the market, creating another threat to home equity. That’s one reason housing policy makers must be careful with regulations that could topple home values.
#3 – Inflation shock
The greatest danger – a slim tail risk, if history is a guide – is that inflation runs away from the Bank of Canada.
While unlikely, this could happen because of another external event, for example, one that disrupts manufacturing and supply chains or drives oil prices into orbit.
Such a case could trigger another 1978 scenario, where inflation unexpectedly drives rates to new highs. That would be nearly the worst-case scenario for a highly leveraged economy like Canada.
All that said, the message is this. With the Bank of Canada poised to hike rates again, there’s no shortage of financial system risks to worry about. But 60-year amortizations are not one of them.
Rates are as of June 29, 2023, from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.