In recent years, the Canadian government has taken steps to cool an overheating housing market by reducing the maximum repayment term from 40 to 25 years for homes insured by the Canadian Housing and Mortgage Corporation (CMHC). According to financial and real estate experts, this reduction was due to concerns about Canadians weighed down by too much debt and a housing bubble.
This reduction in the amortization period has not really cooled the housing market (particularly cities like Toronto and Vancouver). In fact, it’s still hot, hot, hot! With the Bank of Canada maintaining a one percent interest rate, it is still fueling the desire to own a home for first-time buyers and allowing others to trade in their existing home.
Traditionally in Canada, most mortgage terms with banks are closed at five years. Remember, for the first two or three years, a homeowner is primarily paying interest on the mortgage. Now, there are opportunities to have mortgage terms of one or two years, but in most cases it is five years closed. As the five-year term nears renewal, banks give the owner the opportunity to “shop” for better rates. On a side note, a homeowner can ‘buy’ at any time during the five-year term, but if the homeowner moves the mortgage to another institution, he or she will have to pay penalties to the current bank, sometimes up to $45,000.
Over the five-year term, homeowners can be sure of how much they need to set aside each month to cover their household expenses, including the mortgage. But when the term ends, it can become stressful, especially if interest rates go up. Most people typically budget for their home and expenses at the time of home purchase; however, a lot can happen within five years; for example, unforeseen circumstances, such as low income, the birth of a child, the death of a partner, financial problems, or economic changes in the world. If the budget doesn’t leave room to save for the unexpected, it creates an awkward situation.
On the other side of the coin, at the end of the five-year term, banks give customers the option to refinance and that opens the possibility of losing the customer to another institution. This does not promote loyalty to the bank’s brand.
In the United States, financial institutions have provided homeowners with a 30-year fixed-rate mortgage. To get this type of mortgage, the homeowner sometimes pays a slightly higher rate than a shorter-term mortgage and the home takes longer to own.
However, the owner can be assured of a consistent monthly payment, as both principal and interest are spread evenly over the 30-year term. Banks manage to keep their customers close and sell other services.
As recently as early October 2014, interest fell on the 30-year fixed-rate mortgage from 3.97 percent to 3.92 percent. Bloomberg reported a 23 percent increase in people applying to refinance. http://www.bloomberg.com/news/2014-10-23/us-mortgage-rates-fall-with-30-year-at-3-92-.html
There are some benefits of a 30-year fixed mortgage that could certainly help the Canadian homeowner:
– During the mortgage amortization period, the homeowner knows exactly what their mortgage payment is, because the interest rate is locked in for 30 years. There is a sense of security in knowing that and the opportunity to weather any number of unforeseen circumstances.
– The 30-year fixed mortgage allows the owner to save. The savings can be used to pay down the principle faster or allow the owner to purchase other investment products, another win for the financial institution.
– Homeowners are protected from fluctuating interest rates caused by an unpredictable or volatile market. However, if the rate drops from its current rate, they have the option to refinance the loan, just like in the US.
It’s not clear why Canada doesn’t offer a 25- or 30-year fixed-term mortgage like the United States. Some speculate that it is not profitable enough for Canadian banks. There may be other reasons required by the government. However, the advantages of the 30-year fixed term would certainly provide a peace of mind experience for the owner, provide a stable real estate economy, and make banks look more favorable in the eyes of their clients. It would be beneficial for Canadian homeowners to apply to their banks for fully amortized 25 or 30 year mortgages. It may not be easy to get it, but if more people ask, institutions will have to make changes eventually.
It is fair to discuss partially amortized mortgage (five-year term)because it also has advantages.
– It’s a great way to buy a home for lower down payments than a fully amortized loan, allowing for a higher homeowner’s net income.
– Partial amortization loans often require regular payments of interest and principal, with the remaining balance paid off at the end of the term, or refinanced over another five years.
As always, there are downsides, and a homeowner must realistically consider their own personal circumstances. A partially amortized loan is a risk for both the owner and the financial institution:
– If interest rates rise substantially for a partially amortized loan, the homeowner’s monthly cost of the home will increase. In the event that circumstances change and the homeowner is unable to make the monthly mortgage payment as planned, there is a risk of defaulting on the loan.
There is also another solution that provides Canadian homeowners with an alternative to a traditional mortgage. It is known as a 100% HELOC or Home Equity Line of Credit. The benefits of this alternative are:
– The interest rate is usually premium. (variable bank rate) plus or minus .5 percent
– It is an interest only loan and there are no penalties for paying back the loan at any time.
– Because it is an interest-only loan, during tough economic times, the borrower will be required to pay only the interest on the loan.
– As home equity increases, so does loan credit, giving the homeowner access to equity at little or no cost.
– It doesn’t take much to negotiate a lower interest rate, just call your bank and ask.
– It is not necessary to have a savings account with 0% interest paid to you monthly, simply deposit all of your additional funds into the line of credit and enjoy real savings on your mortgage rate.
– Withdraw funds at any time to purchase your second home or investment property, without approval from your bank.
Although the advantages of this alternative outweigh the disadvantages, it is very important to know what the disadvantage is in order to avoid a disaster:
– 100% HELOC is very flexible, maybe too flexible. Homeowners can get into financial trouble by borrowing more than they need. Make sure you have enough equity in the home and follow a disciplined budget when spending.
For more information on a 100% HELOC, call my office and they will connect you with a local mortgage broker who can access this product. If you decide to call your local bank and apply for this product, make sure you don’t get a partial HELOC, which is a normal mortgage combined with a partial HELOC.