With interest rates creeping up, concerns about mortgage affordability can't be far off.
A new government-backed pilot project investigates the practicality of extending mortgage insurance to cover 30-year amortization periods as one way to offset increasing interest rates. Insuring mortgages with longer amortization periods is intended to improve accessibility to home ownership by lowering monthly payments and, therefore, allowing buyers to qualify for larger mortgages.
The four-month pilot project, which began March 3 and runs until the end of June 2006, will offer insured mortgages amortized up to 30 years -- 5 years longer than traditional Canadian residential mortgages. Our federal housing agency, Canada Mortgage and Housing Corporation (CMHC), will assess project results and then decide whether to permanently provide mortgage insurance for 30-year term mortgages, thereby enabling lenders to offer this option.
A mortgage is amortized, or the repayment calculated, over a period of years, generally 25 years, to determine the monthly payment of principal (P) (the amount borrowed) and interest (the cost of borrowing) necessary to take the balance down to zero at the end of that period. Interest in residential mortgages is usually compounded (that's interest on interest) every 6 months. The shorter the amortization period, the higher the payments of principal and interest due monthly, the faster the mortgage is paid off and the smaller the total amount of interest paid over the life of the mortgage. Lengthen the amortization period and borrowing the same amount will cost more.
Some borrowers confuse amortization period with the term of the mortgage, usually a few months or years, set when the mortgage is created and renegotiated on renewal. Term is the contractual period arranged with one lender at a specific interest rate with monthly payments based on the remaining time in the amortization period. Even if interest rates drop or rise dramatically over the term of a fixed-rate mortgage, the interest rate and monthly payments do not change.
Mortgages equal to or less than 75 percent of the appraised value of the property being financed are conventional mortgages and are considered secured by property. Usually, mortgage insurance is not necessary to protect the lender unless it questions the security of the property or borrower.
High-ratio mortgages or those over 75 percent of the appraised value do require mortgage insurance to protect the lender from borrower default, or failure to pay, at a premium paid by the borrower in a one-time charge (usually a percentage of the principal) when the mortgage is first created. According to CMHC, its CMHC Mortgage Insurance allows Canadians to purchase a home with as little as a five per cent down payment and to qualify for interest rates comparable to those offered to buyers with a 25 percent down payment.
Mortgage insurance is also available from private sources. (For more on mortgage insurance, see PJ's articles: First-time Buyers Need More Than CMHC Reduction ; Canadians: Five Percent Will Buy You a Home! ; Canadian Buyers Save Time With Less Down .
Under the pilot program, a premium surcharge of 0.25 percent will apply to residential mortgages with 30-year extended amortizations. Prior to this pilot, extended amortization flexibility beyond 25 years was only available to homeowners under CMHC's affordable housing partnerships and through its Energy Efficient Mortgages product.
Lengthening the amortization period does lower payment costs so that borrowers pay less principal and interest each month, however, it does not make mortgages less expensive for borrowers and may add thousands of dollars to the cost of borrowing over the years. According to CMHC, a borrower arranging a C$190,000 mortgage with a 25-year amortization period and 5% interest rate would pay C$1,100 monthly. By extending the amortization to 30 years, that same borrower would only have to pay approximately C$1,010 monthly. However, that borrower may end up giving an additional C$33,500 to the lender for that five-year privilege. This calculation reflects a constant interest rate throughout amortization period; if rates drop, the total interest cost would be less; if rates increase, the total amount of interest paid could exceed the original purchase price of the home.
The pilot project was launched with FirstLineMortgages , a division of CIBC Mortgages Inc., but it is available through any lenders who choose to participate. CMHC welcomes public inquiries at (800) 668-2642 and lender inquiries through (888) Go emili.
If the 30-year amortization period is not adopted by CMHC, applications for extended-amortization mortgage loan insurance approved by CMHC before the end of the pilot project will remain eligible for this extension, even if mortgage funding has not been finalized and the related real estate transaction does not close until after June 30, 2006.
Improving affordability may be an expensive proposition for lower-income buyers.
