In a February 17, 2011 Financial Post article (“Why do mortgage rates rise fast, fall slowly?”) John Greenwood made a bit of a mess trying to summarize my view on Canada’s five-year mortgage maturity wall:
According to Mr. Kiff, the main reason 10- and 20-year mortgages aren’t more common in Canada is because financial service providers consider them uneconomical.Whenever banks make home loans they generally protect themselves from the risk that the customer may pay the money back early by including strict repayment penalties. But current regulations put strict limits on such penalties. “So the banks have this wall at five years,” Mr. Kiff said in an interview.
Bottom line: Lenders can’t charge what they feel they need to charge so they don’t offer longer term mortgages at an affordable price.
Mr. Kiff, who previously worked at the Bank of Canada, said Canadians would be better served if there was more choice of longer term mortgages. The IMF recently recommended that the federal government change the rules around mortgages so that lenders are able to provide broader product choice without unnecessary limits on how they charge for products.
What needs to happen is “at least, let the market determine where the rates should be,” he said. “What [mortgage] works best depends on the borrower, on the borrower’s own personal situation.”
He’s got the gist of it right. The five-year “wall” is caused by a five-year maturity cap on CDIC deposit insurance, and a prepayment penalty limit on residential mortgage loans in the Interest Act. The deposit insurance cap makes it difficult for banks to cost effectively match lending and borrowing beyond five years. Section 10 of the Interest Act effectively gives homeowners the right to prepay mortgages with a term to maturity greater than five years after five years of payments for a fixed prepayment penalty equal to three months of interest.
In my (“Boring but Effective“) research paper that Mr. Greenwood cites, I speculate that it is possible that, the government is reluctant to remove these restrictions because it prefers to keep mortgage terms short, to reinforce the counter-cyclical impact of short-term interest rate swings. However, it could be merely an unintended consequence of meeting some other well-meaning policy objective…
