Many Canadian homeowners have felt the pain of higher interest rates when it’s come time to renew their mortgage, but a new report from Desjardins says if 10-year terms were more prevalent and attractive, it could have helped lessen the “payment shock.”
When Canadians look at fixed mortgage rates, they often choose to lock into terms up to five years — the length of time your contract is in effect before renewal.
The report says with interest rates declining for years prior to the COVID-19 pandemic, households were “incentivized to borrow at short terms.”
But when the central bank started raising rates in March 2022, those in a short-term mortgage contract began facing renewal at a higher rate.
“Canada is among the countries where the debt service ratio is rising the fastest,” Jimmy Jean, Desjardins vice-president and chief economist told Global News.
“The reason is that we have that renewing feature in our mortgages that many other countries don’t have or have other ways to mitigate. That demands a level of sacrifice on the part of homeowners with mortgages that you don’t see elsewhere.”
According to its analysis, Desjardins says if the option to lock in with a 10-year mortgage term was more promoted and available, “payment shock” would have been more manageable when they go to renew even after rates have risen. It even suggests the mortgage stress test — which sees Canadians qualify for a mortgage at rates higher than what they’ll be paying as a buffer against rate hikes — would be less necessary.
“If you’re able to lock somebody in for 10 years, what do you need a stress test for if that person is not going to be dealing with an interest rate shock over the next 10 years,” Jean added.
Mortgage broker Eitan Pinsky told Global News that the 10-year mortgage term could have been a benefit when rates were much lower in 2020 and 2021, but right now with interest rate cuts expected soon it may not be as appealing to have a longer term.
“You go with a 10-year today, that 10-year rate is too high for it to make sense not to go with the five year rate,” he said.
Desjardins, according to ratehub.ca, currently has a 10-year fixed rate of 5.84 per cent, while a five-year rate sits at 4.84 per cent.
Pinsky added that he has only had one client in his career take a 10-year mortgage and has yet to see inquiries from other clients about such a term, with most looking at three-year terms due to anticipated lower interest rates on the horizon and what he called a likelihood of their renewal rate being “similar” to what they’ve already had in the past.
Mortgage strategist Robert McLister told Global News that most consumers would be happy to take a long-term mortgage under a good rate and flexibility, but a lack of funding for lenders and legislation which he says makes it more expensive to offer 10-year fixed mortgages means there are fewer options.
Add to that the fact most five-year mortgages often offer lower rates.
“You’re probably going to pay more than a shorter term, (and) you’re going to pay a brutal penalty potentially if you have to break the mortgage before the five-year mark,” McLister said.
Those penalties also may deter people from looking into longer-term mortgages as unlike in the U.S., which has 30-year terms, trying to refinance for a better rate before the end of your term could cost homeowners, McLister added. He explained banks charge the greater of three months interest or an interest rate differential to break or refinance your mortgage and while they can only charge the former after five years, if you’re in a 10-year mortgage it’s likely you’ll face a higher cost with the differential.
Even with the call by Desjardins for longer mortgage terms, Jean says obstacles would need to be overcome in order to implement such changes, including updating legislation to change the penalties that exist for prepayments beyond five years, and adjust the limitations on the issuing of covered bonds.
“So a lot of investors would say, well, this is a good deal and the more investors you have, the more likely you can bring those costs down and make it cheaper for the borrower in the end,” Jean said.