Canadian Mortgage Borrowers Are Too Indebted to Fail at Big Six Banks
The comments below are an edited and abridged synopsis of an article by Better Dwelling
The Rise of Long-Term Mortgages in Canada: A Cause for Concern
Canada’s household debt has reached alarming levels, prompting banks and regulators to extend mortgage repayment periods well beyond traditional limits. Despite the implementation of “stress tests” designed to ensure borrowers could handle interest rate increases, many homeowners are struggling with rising rates. Consequently, the Big Six banks in Canada now hold a significant number of mortgages with amortization periods far exceeding the standard 25-year limit.
Canadian Mortgage Limits and Exceptions
Typically, Canadian mortgages are capped at a 25-year amortization period, a measure aimed at preventing households from being burdened with perpetual debt and excessive interest payments. However, exceptions exist, particularly for uninsured mortgages, which may extend up to 30 years under special circumstances. Despite these regulations, the recent trend reveals a substantial deviation from these norms.
Prolonged Amortizations in the Big Six Banks
Recent financial disclosures indicate that over a fifth of BMO’s Canadian mortgage portfolio comprises loans with remaining amortizations exceeding 35 years. Similar trends are seen at CIBC (20%), RBC (19%), and TD (16.5%). The other two major banks (Scotiabank and National Bank) have minimal exposure to such extended terms, primarily because they avoid offering the types of mortgages that contributed to this issue.
The Variable Rate Mortgage Dilemma
A significant factor driving the surge in extended amortizations is the popularity of variable rate mortgages with fixed payments, particularly among investors during the early 2020s. Unlike standard variable rate mortgages where payments fluctuate with interest rates, these loans keep the payment amount fixed, but adjust the portion allocated to interest. The recent sharp increase in interest rates has caused the interest component to consume almost the entire payment, leaving little to no principal reduction. In extreme cases, these loans have become negatively amortizing, meaning the balance actually grows over time, making repayment even more prolonged.
Regulatory Response and Future Implications
The Office of the Superintendent of Financial Institutions (OSFI), Canada’s banking regulator, recognizes the risks of such extended mortgage terms but is also wary of the potential spike in defaults that enforcing stricter limits might cause. OSFI has advised lenders to collaborate with borrowers to find the shortest feasible amortization period that avoids financial hardship. However, without strict regulations or concrete guidelines, this advice remains largely theoretical.
In a notable shift, policymakers are increasingly open to longer amortization periods. Starting August 1, plans are in place to allow first-time buyers with high-ratio, insured mortgages to amortize mortgages on new construction for up to 30 years. Additionally, the state-backed mortgage insurer intends to offer amortizations extending up to 55 years for developers, aiming to mitigate defaults and support the housing market.
Conclusion: A Prudentially Managed System in Question
The extension of mortgage terms in Canada underscores a troubling trend towards increased household debt and financial risk. While these measures provide immediate relief to borrowers, they also raise concerns about the long-term health of the financial system. The ease with which maximum amortizations are extended, seemingly whenever more credit is needed in the market, challenges the perception of Canada’s prudentially managed financial system. As such, while these extended loans may offer temporary stability, they could also be laying the groundwork for future financial instability.
