The Case for Longer Mortgages: Addressing the Mismatch between Term and Amortization

The practice of offering maximum residential mortgage maturity terms of five years, even though amortization periods generally range from 25 to 40 years, is predominant in Canada. This mismatch between mortgage term and amortization creates a need to re-finance or renew the outstanding balloon payments at each maturity of five years or less. It also creates a twofold risk: first, that the lender would choose not to renew the loan if the fair market value of the mortgaged property is less than the principal amount and accrued interest of the loan (or that the lender is unable to renew the loan if it is insolvent), and, second, that the borrower might not find a new lender. At that point, mortgage enforcement might be necessary, and investors would suffer losses. This mismatch, therefore, impedes the development of a market for Residential Mortgage-backed Securities for uninsured mortgages – often referred to as “private label RMBS.” With private label RMBS, the investor – typically an institutional investor such as a pension fund, investment fund, mutual fund and insurance company – would invest directly in a pool of uninsured mortgages without any government backing for repayment. The development of such a market would provide a funding alternative that might enable the federal government to tighten further the requirements for government support of residential mortgages through the CMHC’s securitization programs. Furthermore, it could also lead to further competition in the mortgage market by providing a funding source for mortgages that do not conform with CMHC requirements for insurance or those of the Office of the Superintendent of Financial Institutions (OSFI) applicable to federally regulated financial institutions. This Commentary argues that the best way to address the refinancing risk arising from the term and amortization mismatch would be to facilitate the introduction of a residential mortgage product that does not mature every five years, but matures when it is fully amortized. This product could include an interest rate reset and penalty-free right of redemption at least every five years. Under the current state of the law this can be achieved only by amendment to Section 10(1) of the Interest Act. If Parliament decides to amend Section 10(1), it should also consider lengthening the five-year penalty free redemption right to up to 10 years, thus making it easier for lenders to offer longer-term fixed-rate mortgages to borrowers who would prefer a longer interest rate lock-in period – a move that would also encourage the development of the private label RMBS market in Canada.