Some Canadians have extended the amortization period on their mortgages, and real estate experts say it could bring uncertainty for renewals.
Amortization refers to the time it takes to pay back a mortgage. As elevated interest rates hit the housing market, some people have been have been extending their amortization period out several decades and are only paying interest on their homes.
Daniel Vyner, the principal broker at DV Capital, said in an interview with BNNBloomberg.ca Monday, the trend points to potential default risks and problems for some buyers.
In his view, variable-rate mortgage holders with fixed payments are nearing, or have already hit their trigger rate, which refers to when a homeowner’s mortgage payment is not sufficient to cover the interest accumulated since their last payment.
“These extended amortizations, this is really just a temporary Band-Aid solution, which in my view is preventing mortgage defaults,” he said.
“In other words, if somebody was in an adjustable-rate mortgage where each time this prime rate continued to hike, and they weren't able to afford these mortgage payments, the mortgage would be in default.”
According to The Office of the Superintendent of Financial Institutions (OSFI), around 12 per of uninsured mortgage owners are only covering interest payments, or negatively amortizing.
According to the Canadian Imperial Bank of Commerce’s 2022 annual report, 26 per cent of its residential mortgage portfolio had amortizations at or exceeding 35 years. Toronto-Dominion Bank stated in its 2022 annual report that 25.2 per cent of its residential mortgage portfolio was comprised of loans with amortizations at or exceeding 35 years.
HOW CAN INTEREST RATES AFFECT AMORTIZATION?
Leah Zlatkin, a mortgage broker and expert with LowestRates.ca, said in an interview with BNNBloomberg.ca that the cost of variable rate mortgages has been going up in accordance with interest rate hikes from the Bank of Canada.
There are two types of variable mortgage products, she said, one where your payment changes in line with the central bank's overnight rate and another with static payments, where a person pays the exact same amount each week.
With static payment variable rate products, payments do not increase with interest rates, instead the proportion of interest versus principal in their loan will change, Zlatkin said.
“In order to allow you to pay the same amount of payment and to have the interest rate going up inside of that payment amount and the principal amount being reduced, your amortization – or the length of time within which you need to pay that mortgage back – gets elongated,” she said.
“It extends out in order to accommodate for the fact that you're paying down less principal.”
Zlatkin said the extended amortization periods raise questions about how lenders will deal with the situation when a mortgage is up for renewal.
Historically, mortgage renewals have always “been a given,” she said, where if you couldn't negotiate a lower rate at a different lender, you could typically get a renewal at your existing lender. But there could be uncertainty looming in the next few years for those looking to renew who aren’t able to secure a renewal with their current bank or switch lenders.
“Those lenders may not be as ready to provide those renewals or they may qualify you at [the] time of renewal, and if you don't qualify, they may not issue you a renewal,” Zlatkin said, adding that this will play out over the next three to four years.
Canadians generally pay their mortgages and defaults are uncommon, she said.
Most homes in Canada present good loan-to-value opportunities for lenders, she added, which generally incentivizes banks to renew mortgages, and to help people find ways to continue their payments.
“They don't want a lot of people falling into default, because then they have to power of sale all those houses. What's in it for them? The bank isn't going to want to do that if somebody's going to keep paying them,” she said.
However, there is now uncertainty regarding renewals for people “on the cusp,” who have high loan-to-value on their home, or have potentially defaulted on some payments, Zlatkin said. As a result, people may have fewer options when negotiating their mortgage renewals.
“If you don't qualify somewhere else, you may just have to take what they give you,” she said.
Vyner said that well-capitalized borrowers that have fixed-rate variable mortgage payments are generally not fazed by extended amortization periods. However, he said they understand the “free ride” will end and they will need to “increase these payments or pay down principal.”
“But there are many people that I speak to, (who) are realizing when the maturity date of their mortgage comes and they're going to be expected to either pay down principal or increase this mortgage payment, they're not going to be able to afford this mortgage payment,” Vyner said.
Those who are unable to afford their payments may need to explore their options, Vyner said, which could include things like selling their home, repurchasing or seeking alternative financing.
“At renewal, it's judgment day, and we're going to see if these homeowners are able to make their payments or not,” he said.