Longer Mortgages Would Expand Consumer Choice says C.D. Howe Institute
Longer mortgages would benefit homebuyers and increase competition in the mortgage market, according to a new report from the C.D. Howe Institute. In “The Case for Longer Mortgages: Addressing the Mismatch between Term and Amortization” author Michael Feldman proposes a solution that would expand consumer choice, facilitate a private securitization market and reduce government mortgage risk.
Canadians are typically offered residential mortgages with 5-year terms and 25-year amortization periods, notes the author. As a result, homebuyers owe a large amount on the last day of their mortgage term, before it is fully paid off; such payments are known as “balloon payments.” There is a mismatch between mortgage term and amortization that creates a need for homebuyers to re-finance or renew the outstanding balloon payments every five years.
“This creates a risk to both investors in mortgages and borrowers, if the lender is unable to renew the loan at maturity, and the borrower is unable to find a new lender,” Feldman says.
“If the federal government could facilitate a shift to longer mortgage maturities, borrowers and investors would be better protected from mortgage lenders that become insolvent,” states Feldman.
The author argues that the best way to address the refinancing risk would be to facilitate the introduction of a residential mortgage product that matures when it is fully amortized. This product could include an interest rate reset and penalty-free right of redemption at least every five years in accordance with current Canadian practice. However, in the absence of agreement on an interest rate reset and the failure of the borrower to fully repay the mortgage at that time, the mortgage would become a floating rate mortgage until it matures or is repaid, or until a new rate is set by agreement.
Introducing a longer-term mortgage product would assist in the development of a market for Residential Mortgage-backed Securities for uninsured mortgages – often referred to as “private label RMBS. With private label RMBS, the investor – typically an institutional investor such as a pension fund, investment fund, mutual fund and insurance company – would invest directly in a pool of uninsured mortgages without any government backing for repayment.
Private label RMBS market would provide a funding alternative that might enable the federal government to tighten further the requirements for its support of residential mortgages through securitization programs of Canada Mortgage and Housing Corporation (CMHC).
Furthermore, it could lead to more competition in the mortgage market by providing a funding source for mortgages that do not conform with CMHC requirements for insurance or those of the Office of the Superintendent of Financial Institutions applicable to federally regulated financial institutions.
Under the current state of the law, the introduction of a mortgage product the author suggests would require an amendment to Section 10(1) of the Interest Act. “If Parliament decides to amend Section 10(1), it should also consider lengthening the five-year penalty free redemption right to up to 10 years,” Feldman concludes. “This will make it easier for lenders to offer longer-term fixed-rate mortgages to borrowers who would prefer a longer interest rate lock-in period.”