Rising interest rates have been putting increased pressure on variable-rate mortgage borrowers, in some cases pushing out their amortization periods by decades — at least on paper. But are people really being given 70, 80 or even 90 years to pay off their homes? The Financial Post’s Ian Vandaelle explains what you need to know about extended amortizations and how rising interest rates are affecting mortgages.
What exactly is an ‘amortization’ period and how does it differ from a mortgage?
Essentially, your mortgage and the amortization period are two different ways to look at a path to the same destination. Your five-year mortgage is a contract that sets the interest rate you’ve agreed upon with your bank for the next five years. But very few people are able to pay the full cost of a home in that short a period of time. That’s where the amortization period comes in — that’s how long it would take to pay off your mortgage in full, at the pace you’ve chosen. Typically, the amortization period is 25 years in Canada, a figure that’s a mandatory cap if you have a down payment of less than 20 per cent.
While homebuyers can choose shorter amortization periods, which come with higher monthly payments, Canadian lenders typically do not offer amortizations of greater than 30 years, even for those with 20-per-cent down payments. The 25-year amortization thus remains the norm.
When it comes to mortgage contracts, on the other hand, five years has been the standard, meaning you renegotiate your interest rate with your lender every half-decade. If you stick to your original amortization schedule and interest rates didn’t change, you would go through five five-year mortgages — covering 25 years — before paying off the home in full.
However, at each renegotiation, you can also tinker with the amortization period, essentially moving the goalposts on when you expect to be debt free.
It’s worth noting that not every country does it this way. In the United States, homeowners can lock in a mortgage contract for the full 25- or 30-year amortization period.
If the cap is 25 years, why are we now hearing about amortizations of as long as 90 years?
So, this is where it gets a bit weird — those borrowers won’t actually have nine decades to pay off their mortgages, it just looks that way on paper. The vast majority of variable-rate mortgage borrowers — about three quarters of them, according to the Bank of Canada — have mortgages with fixed payments. In those cases, your monthly mortgage payment is static. But when interest rates rise, the portion of that monthly payment going toward paying down principal shrinks and the portion going toward interest expands. The less principal you pay down, the longer your effective amortization becomes, and that’s the calculation that is appearing on mortgage statements and making the headlines.
But as we said, it’s a paper change. When your contract term is up and you have to renegotiate with the bank, the amortization period will revert to a more normal term, according to Rob McLister, mortgage planner at FixedOrVariable.ca and editor of MortgageLogic.news.
“Once the mortgage matures, the lender that you renew with will typically adjust your payment to get you back on track with your contractual amortization,” he said. “So, if you started off with a five-year mortgage and 25-year amortization, and the amortization zoomed up to 70 years ‘on paper,’ then your new payment at renewal in five years would be based on a 20-year amortization. That assumes you haven’t made additional payments or refinanced.”
So, why is this all happening?
In essence, it’s due to a change in the interest rate dynamics in response to the pandemic. It’s been a roller-coaster ride both with the rapid decreases in the Bank of Canada’s benchmark rate during the worst of COVID-19 and the most aggressive hiking cycle in the bank’s history to try to quell inflation. On the former front, lower rates prompted more borrowers to take on variable-rate mortgages, because they looked cheaper, at least at first. According to Bank of Canada research, variable-rate mortgage originations topped 50 per cent in early 2022, surpassing the share of fixed-rate mortgages, which had been the dominant variety in years past.
But variable mortgages being variable, they were subject to change as interest rates and five-year bond yields rose, increasing the amount of one’s monthly mortgage bill going toward interest.
What happens next?
That all depends on when you’ve got your mortgage up for renewal. There was a spike in home sales and thus mortgage originations through the early days of the pandemic, which means many renewals are coming up in 2025 and 2026. If interest rates have moderated by then, the blow could be blunted for homeowners.
But McLister warned that absent such a scenario, Canadians could be facing materially higher payments.
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“Higher rates and amortization reductions at maturity are an affordability disaster for some folks,” McLister said. “That’s why there’s so much concern about renewal payments in 2024 to 2026. Unless rates dive, many people are going to see 35 to 50 per cent increases in their payments, or more.”
• Email: IVandaelle@postmedia.com