Canadians Embrace Longer Mortgage Amortizations

Written by Posted On Wednesday, 08 August 2007 17:00

A new report by economist Derek Holt of RBC Economics has a positive outlook for the Canadian mortgage market, largely thanks to recent mortgage innovations such as 30-and 40-year mortgages.

"There is enough evidence to convince us that a very material amount of mortgage originations are going for much longer amortization periods," says Holt in the report . "Unlike the cookie cutter conventional 25-year mortgage of the 1980s housing cycle, the past year has seen the introduction of 30-, 35-, and 40-year extended amortization mortgages to broaden the ways in which households can cope with payment shock through higher rates."

Holt says Canadians are embracing these new products faster than expected. Canada's housing market continues to boom, with several centres setting all-time sales records this summer.

Longer amortization mortgages mean that "a rising rate environment may not crimp home affordability as hard as in the past, as typically measured by housing-related payments over income," says Holt. He says that to offset a one percentage point increase in rates, "a borrower would need to go from a 25-year mortgage to a 33-year amortization period, assuming the same house price, while still having the flexibility to pay the mortgage faster later on. In the absence of higher rates, longer amortizations are contributing to upward price pressures in some markets, but also insulate against higher rates."

But consumers who go for a longer amortization need to be aware of what it will cost. A recent survey conducted for credit and information management firm TransUnion found that 45 per cent of Canadians underestimate the lifetime cost of a mortgage. The survey found that "only one-fifth of respondents correctly answered that due to interest payments, the average Canadian homeowner will ultimately pay in the range of 151 to 200 per cent of the original loan amount of the course of a 25-year mortgage," says the company in a news release.

"By the end of a 25-year term, if you have a traditional fixed-rate mortgage at 6.43 per cent, you'll actually pay close to $200,000 on top of your $200,000 mortgage, just in interest," says Tom Reid, TransUnion's director of consumer solutions.

For longer amortizations, it's even worse. Toronto real estate lawyer Alan Silverstein told the Toronto Sun that taking out a 40-year mortgage is "like a life sentence."

The Financial Consumer Agency of Canada includes a chart on its website that demonstrates the good and bad points of longer amortization mortgages. A $150,000 mortgage at a rate of 6.45 per cent, amortized over 25 years, results in monthly payments of $1,000 and total interest payments over the life of the loan of $150,060. Amortized over 35 years, the monthly payment drops to $895 but interest payments jump to $224,800. At a 40-year year term, monthly payments are $865 and interest payments total $264,620.

The idea of the longer mortgages is that buyers will be able to get into the housing market with lower payments now, but will be in a better financial situation in a few years and will begin to pay off their mortgages faster. The FCAC says that using the above example of a 40-year mortgage with monthly payments of $865, if the homeowner can afford to pay accelerated bi-weekly payments (every two weeks) of $432, they will save $80,200 and take 10 years off the mortgage.

There are many other ways to reduce the cost of a mortgage, such as paying down the principal once a year or making double payments when the homeowner can afford it.

With all the concern about the U.S. housing and mortgage markets, Holt says the Canadian mortgage industry "needs to ensure careful market segmentation instead of simply treating new products as more offerings to be mass-marketed."

But he says that so far in Canada, "there is little, if anything, to be concerned about as borrower criteria remain far sounder than in the extreme circumstances stateside." He says mortgage arrears numbers in Canada are "impressive" and that three-quarters of Canadian mortgage-holders "are at fixed rates, but for much shorter terms than in the United States, and the remaining one-quarter will be reset at rising variable rates going forward."

Holt says, "The quality of the Canadian mortgage book is very much marching to the beat of its own drummer. The combined 30-, 60- and 90-day mortgage delinquency rate remains firmly planted at the rock bottom level of one-tenth of one per cent of all mortgages outstanding."

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Jim Adair

Jim Adair has been writing about Canadian real estate, home building and renovation issues for more than 40 years. He is the former editor of Canada’s leading trade magazine for real estate professionals, as well as several home building, décor and renovation titles. You can contact him at [email protected]

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