Expanded terms could help manage payment shocks, says report
Desjardins said long-term mortgage products should become much more widely available in Canada to help homeowners avoid crippling "payment shocks."
Introducing mortgages with longer renewal terms, specifically 10-year mortgage options, could help contain the payment shocks households face when renewing debt after interest rates have risen, according to Desjardins’ report.
"If the option to lock in 10‑year mortgage terms had been more prevalent and attractive, the payment shock would have been more manageable for households opting for it," Desjardins economist Jimmy Jean and macro strategist Tiago Figueiredo wrote in the report.
The lack of long-term fixed options leaves Canadian homeowners overly exposed when interest rates spike, as they have over the past year. Around half of outstanding mortgages have renewed at higher rates since 2022 began.
"The Canadian government is now in a position of having to urge lenders to show leniency toward borrowers facing mortgage renewal shocks," the Desjardins economists said. "This plea might have been unnecessary if better products had existed in the first place."
While 30-year mortgages are widespread in the US, they never caught on in Canada partially because households traditionally preferred taking advantage of decreasing rates by renewing more frequently. Shorter-term mortgages of five years or less currently dominate the market.
"Canadians are spending larger chunks of their income servicing their debt burden than in many other countries amid the global spike in borrowing costs," the authors said.
Part of the reason shorter terms became widespread is that interest rates declined for 40 years before the pandemic, incentivizing households to opt for mortgages that reset rates more frequently.
To make decade-long mortgage terms more affordable, Desjardins recommends legislative changes to limit prepayment penalty restrictions on loans over five years. They also call for developing a residential mortgage-backed securities market and more covered bond issuances to assist with funding.
"If conditions are made ripe for the development of that market, competitive pressures will naturally bring lenders in that direction," said Jean. "It's also in their interest by way of managing risks."
Read more: OSFI warns of risks from extended mortgage terms
The Bank of Canada has flagged concerns over "negative amortization" loans that allow borrowers to add unpaid interest to their principal. But the Desjardins report argues such products "might have been unnecessary if better [long-term] products had existed in the first place."
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