Benefits of longer-term mortgages warrant legislative amendments

In Canada, a residential mortgage typically has a maturity date of five years or fewer, but the country’s central bank has noted that a longer date to maturity would benefit consumers and support the financial system.

As such, regulatory changes and incentives are needed to help longer-term mortgages develop into a significant part of the mortgage market, says a new report from the C.D. Howe Institute published on Tuesday.

Last year, the Bank of Canada (BoC) said longer-term mortgages would enhance consumer choice and financial stability, the report noted. For example, borrowers with longer-term mortgages would face the risk of renewing at high rates less often, the BoC said. Longer terms would also allow borrowers to build up more equity in their homes, giving borrowers greater renewal options. Systemically, longer mortgages would mean fewer borrowers in the economy renewing in the same year.

Yet, only 2% of Canadian mortgages issued in 2018 were fixed-rate loans with terms longer than five years, the BoC said.

The C.D. Howe report explained that longer-term mortgages are rare in Canada because legislation supports a five-year term. A parliamentary statute provides that a borrower has the option to prepay a mortgage at any time after five years, with a penalty of no more than three months’ interest. That puts lenders at a disadvantage.

“If the lender could not re-invest the prepaid amount to earn a rate of return equal to the interest rate of the prepaid mortgage, it would bear all of the forgone earnings opportunity,” the report said.

Lenders avoid the re-investment risk associated with prepayments by offering mortgages and renewals with terms no longer than five years.

For longer-term mortgages to gain a larger proportion of the Canadian mortgage market, the report suggested that the legislation be amended so that a mortgage borrower is given a short-term prepayment right at least every five years, instead of the prepayment right remaining open indefinitely after the first five years of the mortgage.

The report’s other recommendations included loosening the stress test for longer-term mortgages and increasing banks’ covered bond limits to the extent that longer-term mortgages are used as collateral.

For full details, read the full C.D. Howe report.

Michelle Schriver

Michelle is Advisor.ca’s managing editor. She has worked with the team since 2015 and been recognized by the National Magazine Awards and SABEW for her reporting. Email her at michelle@newcom.ca.