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Call for Longer Mortgage Terms Raises Questions STEVE HUEBLMAY 8, 2019
Article Link; https://www.canadianmortgagetrends.com/2019/05/bocs-call-for-longer-mortgage-terms-raises-questions/
Earlier this week, Bank of Canada Governor Stephen Poloz called on banks and other lenders to offer more innovative mortgage products, namely longer-term mortgages.
During a speech in Winnipeg, he said longer mortgage terms would mitigate the normal risks in the system both for lenders and for borrowers. He didnt specify just how long those terms could be, but the longest widely available term in Canada is currently 10 years, while terms of 15, 20 or even 30 years are common in the U.S.
For consumers, the reduced mortgage renewal frequency over the life of the mortgage would remove the risk of renewing into higher rates, Poloz said. Of course, a longer-term mortgage will carry a higher interest rate, but some homebuyers may be willing to pay more to lower their risk, he added.
Just how much more? Rate expert Rob McLister of RateSpy.com suggested a 30-year mortgage, for example, could run around 3.75% or more given where bond market spreads are right now.
And thats probably a best-case rate, assuming a liquid funding market. In the U.S., 30-year rates are north of 4%, he wrote on RateSpy.com. On a standard $300,000 30-year mortgage at 3.75% youd pay $10,829 more interest over the first 60 months aloneversus a 3.00% 5-year fixed.
Little Appetite for Longer Terms
The Bank of Canadas own data shows that currently, just 2% of mortgages have terms greater than five years. And thats for good reason. A longer mortgage comes with certain drawbacks. Aside from paying a higher rate, they would also face a higher likelihood of having to break the mortgage early.
Even though mortgage terms longer than five years are protected by the Interest Actwhich means the penalty for breaking that mortgage would be limited to three months interest (vs. an IRD penalty) after the first five yearsa multi-decade term would heighten the likelihood of borrowers breaking their mortgage early.
For that reason, Ron Butler of Butler Mortgage said mortgages of that length would have to be exempt from breakage penalties, similar to the no penalty system in place in the U.S.
Even Canadas most popular mortgage termthe 5-year fixedis longer than most borrowers stick with their current mortgage for. James Laird, President of CanWise Financial and co-founder of Ratehub.ca, says stats show most mortgage terms are kept for just shy of four years.
Some might suggest that perhaps its bad advice to be recommending these longer terms, Laird said. Because even though the borrower might feel settled, we know that life events occur, which can cause people to break their mortgage more quickly than they are expecting.
Additionally, he said borrowers would need a compelling reason to pay more for the security of a longer term, namely the expectation that interest rates are going to rise over that time. Plus, the extra cost to lock in would have to be reasonable.
If those two things are occurring, and you have a household that thinks theyre not moving for 10 years, okay, youve got ingredients for someone to take a longer term, Laird said, adding the last time he saw those ingredients come together was in 2012 when 10-year fixed rates fell below 4.00%, 5-year rates were above 3.00% and many expected interest rates to rise. But the Governor doesnt help his case by telling us rates are not going to move for a sustained period of time. That is not a good reason to go with a longer term. Thats justification for taking a variable rate or short term.
An Answer to the Stress Test?
Polozs call to arms for the industry to introduce longer mortgage terms appears to be a response to criticism over the governments stress test, which has sidelined the buying intentions of an estimated 40,000 homebuyers since it was introduced last year.
The Bank of Canada has a particular view of the stress test as a means to reduce leverage and tamp down soaring prices, Butler said, suggesting theyre floating the idea of longer mortgages as an alternative solution to assisting homebuyers as opposed to adjusting the stress test.
Poloz himself said, The longer the mortgage term, the less relevant a mortgage interest-rate stress test becomes, pointing to the increased amount of equity built up in between renewal periods.
Up to Government to Create the Appropriate Conditions, Not Lenders
But not everyone believes the onus should fall on the industry to develop solutions to make longer-term mortgages more attractive.
I found it interesting that Poloz is calling on others to make this happen when, in my opinion, its the policy-makers in Ottawa who have actually completely taken away any incentive to lock into a longer-term fixed rate, Laird said, pointing to the stress tests added qualification burden on longer-term rates.
For a 10-year rate at 4.00%, the borrower instead needs to qualify at 6.00% vs. a qualification rate of 5.34% for a shorter term fixed or variable rate, Laird noted. In my opinion, the tools are in (Polozs) hands and the other regulatory bodies in Ottawa. If theyre thinking, Lets get more borrowers into longer-term fixed rates, they can make that happen.
McLister added that if the government is serious about this, it would also have to facilitate cost-effective long-term funding to support those mortgages.
Government-sponsored funding vehicles (like the NHA MBS and Canada Mortgage Bond programs) currently only support up to 10-year terms and are dominated by 5-year securities, he noted. Private mortgage-backed securities, in their current incarnation, would not have tight enough spreads to allow for competitive 30-year rates.
Butler agreed, saying, Vast changes would be required in our mortgage financing system.
In other words, dont hold your breath for cost-effective longer-term mortgages anytime soon.
NORTHERN STAR (FOR NOW...)
In contrast to the US, Canadian growth is accelerating sharply going into the second quarter, following a solid gain in domestic demand to start the year.
Fast, and accelerating, population growth, and remarkably strong employment growth are providing a solid underpinning to consumer spending and the housing market.
Positive export data suggest that the ongoing strength in domestic demand will be buttressed by net exports in the second quarter, and possibly beyond.
Canadian inflation is at the Bank of Canadas target, in sharp contrast to the US, where it has moved away from the Feds objective. This gives the BoC room to keep rates on hold if inflation remains on target.
Downside risks remain important and are all linked to US-centric developments, with worries about US trade policy ongoing despite the pause with China.
Recent Canadian developments stand in sharp contrast to events in much of the rest of the world. Whereas US growth is clearly decelerating, Canadian growth is on an upswing, with recent indicators pointing to a very sharp rebound from a somewhat sluggish start to the year. Canadians appear to be, for the time being, largely insulated from the broader malaise facing the global economy as consumer and business confidence has improved sharply in recent quarters, owing to strong sales and job creation. While there are a number of factors suggesting that the growth rebound observed will persist through 2020, there is a risk that a divergence between Canadian and US outcomes may not last.
Source: Scotiabank Economics
CANADA — SETTING THE AUTUMN TABLE
The Bank of Canada will have the opportunity to set a course of action or, more likely, inaction for some time at least into the Fall when it delivers its latest policy communications on Wednesday July 10.
Key may be how the BoC views external risks that it warned had increased in May. Further, watch for key guidance toward Q3 GDP. Recall that the BoC only forecasts out a quarter at a time and the April MPR published quarterly GDP growth up to 2019Q2. While it has to revise up that 1.3% estimate for Q2 to something that would probably be deep in the 2s perhaps bordering upon 3%, how the BoC views the durability of this improvement relative to potentially temporary and distorted drivers is key by way of assessing 2019H2 risks.
In the meantime, the case for the BoC to stand pat on rates for some time is guided by the following points:
The BoC is starting at a more relaxed policy stance than the Fed with slightly negative real rates and below its neutral rate. This gives the BoC more of a policy buffer against downside risks;
The BoCs preferred core inflation measures are on- if not a smidge above-target at 2.1% y/y while the Feds preferred gauge is well below 2% at 1.6%.
C$ weakness is the flip side to the implications of US dollar strength. The CAD rally of about a nickel since early June has been backed by firmer commodity prices. Further C$ appreciation may be limited if the Fed cuts because US monetary policy easing is already significantly priced in;
Canadas economy is on the rebound in Q2 whereas the US is decelerating;
Domestic trade policy risks are less negative for Canada now given the CUSMA deal that is pending passage in the US and Canada (but passed in Mexico) and the reversal of steel and aluminum tariffs and reciprocal actions;
housing markets are stabilizing in Canada, driven by job growth, lower mortgage rates and distance from B20;
nonfarm payrolls disappointed in May but Canadas job growth has remained strong this year;
Canada has imported bond market easing driven by Fed rate expectations and to a degree can ride along the Feds coat tails.
Source: Scotia Economics