Growing number of mortgage loans have amortization periods of more than 30 years

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A growing share of mortgage loans made by major Canadian banks have amortization periods of more than 30 years, a sign of the rising stress borrowers are under as interest rates soar.

With every interest-rate hike by Canada’s central bank, the cost to service a variable-rate mortgage rises. But at most banks, the borrower’s monthly payment doesn’t increase right away. Instead, the amortization period – the time it takes to pay the loan off in full – gets longer. When the loan’s term comes up for renewal, the amortization has to snap back to its original length, which in the current environment of rising rates forces a sudden increase in monthly payments.

At Royal Bank of Canada RY-T, Bank of Montreal BMO-T and Canadian Imperial Bank of Commerce CM-T, the percentage of mortgages with an amortization of more than 30 years recently doubled in a three-month span, according to company filings. That is one of the clearest indicators that stress is building on variable-rate mortgage holders, who are increasingly paying more interest and less principal on their loans.

At RBC, the country’s largest mortgage lender with about 310,000 variable-rate mortgages, roughly 125,000 mortgage clients have reached or are nearing a trigger point that requires an immediate increase in monthly payments, according to Leah Robinson, vice-president of home equity financing policy and regulatory management.

Mortgages with terms of more than 30 years accounted for one quarter of the banks’ residential mortgage portfolios as of July 31. At the end of April, those loans made up 10.6 per cent of BMO’s portfolio, and 12 per cent of mortgages at RBC and CIBC.

A larger proportion of mortgages with long amortizations gives an indication of the number of borrowers who could face significant hikes to monthly payments.

“The vulnerability is spreading,” said Robert Colangelo, senior credit officer with credit rating agency Moody’s Investors Service. “If that percentage increases, it implies that more variable-rate mortgage holders are vulnerable to a much higher mortgage payment.”

Carole Saindon, a spokeswoman for Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), said in an e-mail that “OSFI expects lenders’ risk management to be responsive to changing conditions, and practices to be adjusted accordingly.”

In late August, CIBC executive Shawn Beber said his bank has $7-billion of variable-rate mortgages up for renewal in the next 12 months, but less than $20-million in balances with clients that the bank views as being at high risk of delinquency. A spokesman for the bank, Tom Wallis, said CIBC reaches out to clients facing payment shocks and gives them options that include “increasing their payment and/or converting to a fixed term at any time without penalty.”

BMO spokesman Jeff Roman said the bank is in regular contact with their variable-rate mortgage clients and works with them to find a solution when they are nearing the trigger rate for a higher monthly payment.

A variable-rate mortgage is based on a bank’s prime lending rate, which typically moves with the Bank of Canada’s benchmark interest rate. Those rates have quickly jumped higher as the central bank raised its benchmark rate to 3.75 per cent, from 0.25 per cent in early March.

For variable-rate mortgages with constant monthly payments, the prime lending rate dictates how much of each payment goes toward paying down principal or interest costs. When prime goes up, more of the borrower’s monthly payment goes toward interest.

Because the monthly payment doesn’t typically change until the current mortgage term expires, the time it will take to repay the loan gets longer as interest rates rise. There is no across-the-board maximum amortization period, though OSFI said it expects financial institutions to set thresholds when they underwrite loans.

At renewal, the term of a variable mortgage usually has to be brought back to its original amortization. For many borrowers, that will mean their monthly payment suddenly jumps higher, unless they have spare cash to make a lump-sum prepayment toward the principal, or switch to a fixed-rate mortgage.

And borrowers can only lengthen their amortization or change the loan’s core terms by refinancing it, which is akin to taking out a new loan: It requires the borrower to requalify and be stress-tested, proving they can make mortgage payments with an interest rate that is at least two percentage points higher than their actual mortgage rate.

At today’s average five-year fixed mortgage rate of 5.5 per cent, that means the borrower would have to prove that they could make mortgage payments if the interest rate was 7.5 per cent – a prohibitively high bar for some homeowners.

When interest rates rise rapidly enough that the monthly payment on a mortgage no longer covers the interest owed, it typically triggers an immediate increase to the payment amount. That is to prevent the mortgage from growing larger even as the borrower makes payments.

By contrast, some banks including Bank of Nova Scotia structure variable mortgages such that monthly payments adjust regularly as interest rates rise or fall, meaning borrowers get more gradual but immediate changes to their monthly mortgage costs.

Mortgage experts estimate that the monthly payment for variable-rate mortgages has jumped significantly since Canada’s central bank embarked on its campaign to quell inflation.

Samantha Brookes, chief executive of mortgage brokerage Mortgages of Canada, said it would be difficult for many households to come up with the extra cash to service their loans.

For example, a homeowner who got a $800,000 mortgage with a variable rate of 1.35 per cent in January with a 25-year amortization would have paid $3,143.42 monthly, with the bulk of the mortgage payment going toward paying down the loan, according to Ms. Brookes. With today’s variable rate of 5.1 per cent, that same homeowner would pay $4,723.45 per month, and most of the payment would go toward interest.