When I think of amortization periods, there are two numbers that immediately come to mind.

The first is 25.

The second is 40.

Why those two numbers?

Well, because the most common amortization period is twenty-five years, and it’s effectively the “default” period for most borrowers.  I don’t have statistics on this (chime in if you’re in the mortgage field), but I would guess that an overwhelming majority of borrowers in Canada elect to take a 25-year amortization period.

The second number that pops up in my head is “forty” and that’s because the 40-year amortization was a huge seller, circa 2005 – 2008, but was done away with after the Financial Crisis in the United States in 2008.

Short history lesson here, but the Financial Crisis, which I’m electing to capitalize, was a learning experience for Canada’s mortgage industry.

We’ve all read “The Big Short,” or seen the movie with Christian Bale, and we all know how the sub-prime lending crisis caused the Financial Crisis in the United States, which then had worldwide implications.

As a result, the Bank of Canada then took significant steps to strengthen the already strong Canadian mortgage industry, implementing several important changes.

I remember when a buyer could obtain 107% financing on a property, meaning they pay $0 out of pocket for the house or condo, and get 7% back in cash.

The Bank of Canada did away with that and instituted a minimum 5% down payment, as well as a 20% down payment for properties over $1,000,000.

Those were massive changes!

But we also saw a minimum down payment of 20% instituted for second properties or investment properties, which was also a game-changer.  Investors used to be able to buy properties with only a 5% down payment.  Imagine buying a $300,000 condo with $15,000 down, then doing it again, and then again?

But the change that seemed relatively quiet at the time was the abolishment of the 40-year amortization.  Some people noticed, some people cared, but few thought it was as significant as the minimum down payment requirements.

Just consider what it was like back in 2008 when you could purchase a $300,000 condo with 5% down, and a 40-year amortization.

At a rate of, say, 4.99%, your monthly payment would be $1,386.50.

But with an amortization period of only 25-years, your payment would soar to $1,693.95.

That might not sound like a “soaring increase to you,” since on an absolute basis, it’s only a few hundred dollars, but on a relative basis, it’s 22%.

But let’s use today’s prices just to illustrate the difference.

Say you’re purchasing a $1,400,000 home with a 20% down payment, at 5.99%.

On a 40-year amortization, that’s $6,097.40 per month.

But on a 25-year amortization, that’s $7,159.18 per month.

Without the 40-year amortization, monthly payments increased, affordability decreased, and the Bank of Canada had hoped that demand would as well.

In 2008, these changes were intended to strengthen the mortgage world.  But as the years went on, politicians began to believe they could “solve” the housing crisis by reducing demand.  We all know how that worked out…

After the 40-year amortization was wiped out, circa 2008 (correct me if it was 2009), the maximum that a traditional borrower could amortize their loan was thirty years.

Today, it’s primarily either 25-years or 30-years with your “Big Five” banks.

Sub-prime lenders like Equitable Bank do offer a 40-year amortization, but their market share is negligible compared to the Big Five.

Earlier this year, we started to see a lot of articles in the media about “increasing mortgage payments,” and that hasn’t slowed down at all.

We’ve also been seeing news of late about “mortgage renewals,” and specifically I mean this one from the Globe & Mail

“Canada’s Economy Faces $900-Billion Mortgage Renewal Shock”
The Globe & Mail
November 2nd, 2023

To be fair, the title was editorialized just a little by adding the word “shock,” since the story is really about mortgage renewals, and the relative shock is up for debate.

From the article:

Between 2024 and 2026, an estimated $900-billion worth of Canadian mortgages – almost 60 per cent of all outstanding mortgages at chartered banks – are due to renew and could face a sharp increase in payments, according to a report released this week by Darko Mihelic, an analyst who covers the banking sector for RBC Capital Markets. Those payment increases range from a weighted average of 32 per cent next year to 48 per cent in 2026.

The biggest shock awaits fixed-payment, variable-rate mortgages set to renew in 2026. A five-year variable mortgage renewing that October would see payments jump 76 per cent if mortgage rates stayed around 6 per cent. A one-percentage-point drop to 5 per cent would ease the payment shock, but only to 63 per cent. “Interest rates would need to decline significantly to ‘save’ this cohort,” the report says. Even if the Bank of Canada were to slash its benchmark rate to 0.25 per cent by that year, payments for variable-rate mortgages as a whole would still shoot up 20 per cent.

What’s missing in this article is the reason why so many mortgages are up for renewal between 2024 and 2026, which is that more people took shorter mortgage terms in the last 18 months as they hoped to time the interest rate cycle, and renew at lower rates sooner.

But the article continues:

There have been fears these increases could lead to a rise in defaults, but Mr. Mihelic believes those fears are overblown. That’s because banks are already taking measures to help overstretched borrowers, such as working with their clients to increase monthly payments or extending the amortization of their loans.

Ah, okay!

So then this article was pointless.

Got it.

Note the last section of that paragraph:

“…increase monthly payments or extending the amortization of their loans.”

That is what I wanted to discuss today, and that is why, in theory, the 100-year amortization that we see in other countries around the world is coming to Canada!

Finland currently has 60-year amortizations.

Once upon a time, Switzerland and Japan had 100-year amortizations.

But we tout that here in Canada, with our safe banking system, we “only” have 25-year and 30-year amortizations.

That is, at the onset.

But if variable-rate borrowers see interest rates skyrocket and they can no longer afford their payments, that’s where the long amortizations come into play.

Consider that not all variable-rate mortgages produce fixed monthly payments.

Whereas TD Bank’s mortgages have a fixed monthly payment with variable rates, ScotiaBank does not.

Perhaps an example?

If you bought a $1,000,000 home with 20% down, a 25-year amortization, and a 2.99% variable interest rate, your monthly payment is $3,360.57.

When the variable rate increases to 3.99%, a similar borrower would see a monthly payment of $3,799.62.

But for the borrower who has their “fixed payment,” their monthly payment doesn’t change from $3,360.57 to $3,799.62, but rather the portions of principal and interest within that $3,360.57 monthly payment change.

The borrower that does not have the fixed payment would see their payment go up.

And that is where all this talk about “shock” came into play.

Imagine that you’re paying $3,369.57 per month and then interest rates move from 2.99% to 3.99%.  Now, you’re paying $3,799.62.  Then when rates go to 4.99%, you’re paying $4,264.75.  And when rates hit 5.99%, you’re paying $4,753.59.

See how important your mortgage terms are?

For the buyer with the fixed payment, their monthly payment doesn’t increase.

It’s those buyers with banks like Scotia who see their payments increase massively.

But as the article above says, what if the borrowers can’t afford the increased payments?

Well, then the bank has to change the amortization period of the mortgage to keep the payments manageable.

Let’s say that you’re paying $3,000 per month on your variable rate mortgage, but rates increase, and now the bank is expecting you to pay $4,500 per month.

But you can’t afford it.

So the bank agrees to keep your payment at $3,000 per month, but they take that additonal $1,500 per month that you owe, and they add it back to the original loan.

$1,500 per month over twelve months is $18,000 per year, and that is how the amortization periods are increasing.

I bookmarked this topic several months ago, and thus this article is stale-dated but still relevant:

“Lenders Now Seeing 60, 70, Even 90-Year Mortgages As Canadians Struggle With Rocketing Interest Rates”
Toronto Star
June 27th, 2023

From the article:

Now, in the face of crippling interest rates, some existing homeowners are seeing their amortization period go as high as 90-years as their ‘fixed-payment’ variable-rate mortgages adjust automatically to rising interest rates while the monthly payment remains the same.

See how we get to the “90-year amortizaton?”

The bank isn’t going to offer you a 90-year amortization when you take out your initial mortgage.  They’ll offer you a 25-year or 30-year amortization.

But when interest rates increase and a buyer can’t keep up with the increased payments, then the bank “works with” the borrower and increases the amortization.

Some of you not familiar with the math might ask, “Who cares?  If a $3,000 payment remains at $3,000, then who cares what the amorization period is?”

But you have to consider that within every monthy payment there is a portion of principal repayment (paying off your debt) and a portion of interest (money you don’t get back).

Here’s an example:

You buy a house for $1,000,000 with a 20% down payment, a 2.99% interest rate and a 25-year amortization.

Your monthly payment is $3,781.86.

In the first year of the loan, the repayment breakdown is as follows:

Principal: $1,826
Interest: $1,956
Total: $3,782

With every payment of $3,781.86, you’re paying down $1,826 of principal.  Another way of explaining this is “forced savings.”

But let’s say that your amortization is 40-years.

Your payment drops to $2,850.77 per month, which is why people loved these 40-year amortizations!

But your repayment:

Principal: $882
Interest: 1,969
Total: $2,851

The longer the amortization, the less you’re paying down.

And the problem with the increasing rates is that, eventually, you could reach a point where $3,781 per month is interest and only $1 is principal.

OSFI doesn’t like fixed payments on these variable rate mortgages because of the risk of amortizations essentially being infinite.

But the fixed payments exist and thus the banks often keep the payments the same but raise the amortizations.  When that happens, the borrowers aren’t paying down any principal on their homes.

In the case of a fixed payment where rates increase so much that the interest owed is greater than the actual monthly payment, then the monthly payments must increase.

And in many cases right now, we’re seeing both happen: the monthly payments increase and the amortizations are extended.

So while the day will almost certainly never come where you can walk into Royal Bank and ask for a new mortgage with a 100-year amortization, we will effectively see these amortization periods enacted on existing mortgages in this increasing interest rate environment.

How ’bout that.

Who doesn’t love some mortgage math on a Friday morning?