Extending amortizations is a common method used by lenders to provide relief for Canadian homeowners struggling with mortgage payments due to higher interest rates. However, experts and regulators are cautioning that this strategy can have hidden costs and risks for consumers. Initially, amortizations for insured mortgages are limited to 25 years in Canada, but they can be extended beyond 30 years by lenders on a temporary basis until the mortgage is up for renewal.
When homeowners reach their trigger rate, where their payments are insufficient to cover the interest on the loan, they enter a negative amortization situation where the time to pay back the loan continues to increase. Eventually, these mortgage holders must make changes to catch up, which may involve making a lump sum payment, increasing their monthly contributions, or extending the amortization period.
According to Desjardins analyst Royce Mendes, over 20 percent of the mortgage portfolio held by the big six Canadian banks had a repayment period longer than 30 years in the first quarter of this year, compared to about two percent a year ago. Extending amortizations is also an option for other mortgage holders, including those with fixed-rate mortgages coming up for renewal and considering refinancing, to lower their monthly payments.
Penelope Graham, director of content at rate comparator website Ratehub.ca, emphasizes that extending amortizations should be seen as a temporary solution for mortgage relief, as the additional costs incurred when extending the amortization can quickly accumulate. Ratehub’s analysis demonstrates the importance of keeping amortizations in check. For example, extending a 25-year amortization to 30 years on a $500,000 mortgage at a typical five-year variable rate of 5.8 percent can save the consumer around $227 monthly. However, letting interest accumulate on the loan for an extra five years would increase the overall payments on the mortgage by over $100,000.
“The biggest risk for borrowers is that when you extend your amortization, you exponentially increase what you’re going to owe on your mortgage because the longer your amortization, the more interest you’re paying over a greater period of time,” explains Graham.
The Financial Consumer Agency of Canada (FCAC) recently issued new guidelines to standardize the practice of extending amortizations among federally regulated financial institutions. The FCAC guidelines emphasize that if amortizations are to be extended, they should be done for the shortest period possible. Lenders should also consider the risks to consumers who need to revert to the original amortization period at renewal.
Extending amortizations far beyond their original timeframe and reducing monthly payments can lead to a sudden jump in payments when mortgage holders renew their mortgages, highlighting the risks associated with relying too heavily on extending amortizations. The limits for amortizations are set by the Office of the Superintendent of Financial Institutions (OSFI), which is currently reviewing mortgage rules for lenders. OSFI has urged banks to address the risks of amortization extensions and negative amortization as soon as possible.
While increasing the maximum allowable amortization in Canada may make monthly payments more manageable and help more consumers enter the housing market, it also increases risks in the financial system. Graham believes that OSFI would be cautious about removing safeguards from the system at a time when many mortgage holders are already facing the challenges of higher interest rates.
In conclusion, while extending amortizations can provide temporary relief for Canadian homeowners struggling with mortgage payments, it is important to be aware of the potential costs and risks involved. Consumers should consider it as a short-term solution and be mindful of the long-term implications of extending their amortizations.
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