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A recent report from Desjardins sheds light on the challenges Canadian homeowners face with rising interest rates during mortgage renewals. The report suggests that if longer mortgage terms, particularly 10-year ones, were more common and appealing, it could mitigate the financial strain known as "payment shock."
Typically, Canadians opt for fixed mortgage rates spanning up to five years, the duration before renegotiation. Prior to the pandemic, declining interest rates encouraged borrowing at shorter terms. However, as the central bank began raising rates in March 2022, those with short-term contracts faced renewals at higher rates, contributing to a rapid increase in the debt service ratio, according to Jimmy Jean, Desjardins' vice-president and chief economist.
Desjardins argues that promoting and offering 10-year mortgage terms could soften the impact of rate hikes during renewals. It suggests that longer-term mortgages could reduce the need for the mortgage stress test, which currently qualifies Canadians for mortgages at rates higher than what they'll pay, acting as a buffer against future rate hikes.
While a 10-year term might have been advantageous when rates were lower in 2020 and 2021, mortgage broker Eitan Pinsky suggests that with anticipated interest rate cuts, shorter terms may now seem more appealing. Currently, Desjardins offers a 10-year fixed rate of 5.84%, compared to 4.84% for a five-year term.
Despite Desjardins' recommendation for longer terms, few Canadians are opting for them. Mortgage strategist Robert McLister attributes this to limited funding for lenders and legislation that increases costs for offering 10-year fixed mortgages. Additionally, the lower rates often associated with five-year mortgages and potential penalties for breaking longer-term contracts deter homeowners.
McLister notes that unlike in the U.S., where 30-year terms are common, Canadian homeowners may face higher costs if they try to refinance before their term ends. Banks typically charge the greater of three months' interest or an interest rate differential to break or refinance a mortgage, with the latter being more costly for longer-term mortgages.
Jean acknowledges the hurdles to implementing longer mortgage terms, including updating legislation regarding prepayment penalties and adjusting limitations on issuing covered bonds. Overcoming these obstacles could attract more investors, potentially reducing costs for borrowers in the long run.
