January 21, 2020 – Longer-term mortgages would enhance both consumer choice and financial stability, but regulatory changes are needed to help them develop into a significant part of the Canadian residential mortgage market, says a new report from the C.D. Howe Institute.
In “One More Case for Longer-Term Mortgages: Financial Stability,” author Michael K. Feldman notes that according to the Bank of Canada only 2 percent of all Canadian mortgages issued in 2018 were fixed-rate loans with terms of longer than five years. He further suggests that encouraging 10-year or longer mortgages would increase options for borrowers while adding more stability to the housing market.
In May 2019, Bank of Canada Governor Stephen Poloz pointed out that if more borrowers had longer-term mortgages they would face the risk of having to renew at higher rates less often. Also, from a systemic point of view, there would eventually be fewer borrowers in the economy renewing their mortgages in the same year. Finally, Poloz noted that longer terms allow the borrower to build up more equity in their home, giving the borrower greater options at renewal.
Feldman first explains why longer-term mortgages are rare. He notes that the popularity of the five-year term arises from the passing by Parliament of the Interest Act (Canada) in 1880. Section 10 of that Act established a five-year term after which the borrower has the right to prepay at any time with a penalty of three months’ interest. This means that lenders are reluctant to offer terms of more than five years because they would assume the risk of reinvesting the proceeds if a borrower chose to pay off the mortgage.
“For longer-term mortgages to comprise a significant portion of the entire Canadian mortgage market it will likely be necessary for the federal government to modify certain rules that are currently geared towards a five-year mortgage market,” said Feldman. “The custom in Canada for residential mortgages to have legal maturity of five years or less is too well-entrenched to be overcome organically without incentives or changes to laws or government policies and programs to encourage this development.”
In order to significantly change the dominant custom in Canada of residential mortgages being five years or less, the federal government would likely have to provide inducements to borrowers and lenders, as well as amending certain regulatory practices. The report recommends:
- Loosening the stress test requirements for longer-term mortgages, allowing borrowers to qualify for larger mortgages by extending the period they are willing to fix their terms.
- Amending section 10 of the Interest Act to provide that so long as a borrower under a residential mortgage was given a short term prepayment right in respect of their entire mortgage at least every five years, then this prepayment right did not have to remain open indefinitely after the first five years of the mortgage.
- Increasing covered bond limits but only to the extent that longer term mortgages were used as collateral.
- Developing the market for private Residential Mortgage-Backed Securities (RMBS) – These securities (which would not be backstopped by the government through CMHC) would help both lenders and borrowers seeking long-term mortgages and investors seeking alternative longer-term investments.
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada’s most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.