Extended Amortizations Have A Place

We’ve been hearing a lot about the “evils” of 40-year amortizations lately.  People like Garth Turner have gone so far as to equate them with subprime mortgages.

They do have a place, though, and it’s becoming clear that the debate is in need of balance.

Peter-VukanovichPeter Vukanovich, President of Canada’s 2nd largest mortgage insurer, Genworth Financial, talks about 40-year ams. in a recent issue of the Hill Times.

Vukanovich says concerns about extended amortizations “are misplaced.”  Long amortizations “should not be confused with subprime mortgages,” he says.  “Unlike subprime loans, extended amortization products are intended for ‘prime’ borrowers with a good credit history.”

Vukanovich cites three examples of borrowers that are well suited to 40-year ams.:

  • Early-career borrowers with higher income earning potential
  • Those who anticipate other significant short-term expenses
  • People trying to buy into higher priced urban markets

Add income property investors to the list as well.

Granted, the stated interest on 40-year amortizations is huge versus the 25-year variety.  But it’s the effective amortization that’s most important suggests Vokanovich.  He notes that most Canadians pre-pay their mortgage well ahead of time.  (Although probably not the ones destined to default – Ed.)

Doing something as simple as moving from monthly to accelerated bi-weekly payments cuts a 40-year amortization down to 32 years.  Applying lump sums (like tax refunds) can save tens of thousands of dollars more.

In the end, 40-year ams. probably won’t spark mass defaults or the implosion of Canada’s real estate market.  The “correction” will likely be economy driven.  So until there is evidence to the contrary, 40-year mortgages will keep being promoted by lenders and keep being eaten up by the public.

  1. I wholeheartedly agree with Vukanovich’s statements. I’m an example of a home buyer who *could* have gone with a 25 year am, but instead chose the 40-year with bi-weekly payment acceleration, but also pre-set bi-weekly lump sum payments.
    The reasoning behind it was simple: if for whatever reason, I find myself falling onto hard times (although I always ensure to have a strong rainy day account), the 40-year am gives me the *flexibility* to reduce my monthly payments substantially (for a temporary time until I land on my feet).
    This flexibility alone, for those of us more than capable of paying the accelerated payments and lump sum, is worth the price of admission. I also own an investment property with a 40-year am to specifically take advantage of the deductible interest payments.
    All of these doomsday 40-year am “is evil” statements strike me as unnecessarily alarmist (chicken little syndrome).
    Just my $0.02.

  2. Interesting – I agree that the longer amortization is just a tool – it’s not inherently a bad thing especially if it’s used for a good purpose.
    Questions for you – do the long amortizations change the costs at all – ie higher interest rates?
    Also – Vukanovich mentioned that most Canadians pre-pay their mortgage (to some degree I guess). Is this true? I thought I’ve read here and elsewhere that most Canadians don’t do this?
    thx, Mike
    p.s. – you guys should add the comment email subscription option to make it easier to follow the comments for a particular post. We use a plugin called ‘subscribe to comments’.

  3. There are exceptions to every rule, and Dan, you are probably the exception in this case.
    People should not be deluded into thinking that 40 year mortgages are just a “tool”. Sure they are a tool, but the tool is now a neccessity because of the low affordability of homes, which are now less affordable than they were in 1989, prior to the huge bust.
    The only way the housing market (aka pyramid scheme) can be sustained at current prices is to have first-time buyers spread their payments over 40 years instead of 25, effectively doubling the amount of mortgage interest they will have to pay. Yes, the poor get poorer, which seems to be a common theme these days, as indicated by the Census data released yesterday.
    Suggestions that people will pay down their mortgages early is an irresponsible defense of this “tool”.

  4. FP – with respect to higher interest rates, I would suspect it all depends on the credit history of the borrower.
    In my case, I was able to secure a variable (prime – .9), a rate which seemed the best option at any amortization level (across most institutions). The factors that seemed to come most into play is household income vs. debt liability in addition to historical (ie: Beacon) ratings.
    Here’s an underlying question I often wonder — are mortgage brokers compensated at higher rates if they sign their clients into the 40 yr am products? If amortization lengths are factored into commission payouts, it then begs the question of in who’s best interest do they work for ultimately?

  5. Dan,
    That is an excellent question. I recall reading that many of the brokers at Countrywide in the US were indeed compensated at higher rates when they were able to steer people into mortgages that were more profitable for the company.
    IMHO, the entire industry is stacked against the buyer.

  6. I suspect Dan is not the exception here; I recently used exactly the same reasoning.
    The 40 year product, for me as a buyer, is a risk reduction strategy with no cost except for discipline. “Closed” mortgages now offer such a wide variety of pre-payment options that it doesn’t make sense to “lock-in” to the highest minimum payments possible.
    I agree that housing affordability is down, but to see the popularity of the 40 year product as definitive proof of this is just as flawed as saying the party will never end …

  7. Chris, I think your argument is flawed and by saying so, this is a compliment to you and Dan. You two are obviously well educated on the issue at hand and look beyond the mainstream media to form your opinions and make informed decisions. Sadly, I think you and Dan are in the VAST minority.
    I don’t say that the 40yr mort is “definitive proof” of the impending downturn, but rather that it is yet another factor which suggests to me “the party is going to end”. The main factor is that home prices cannot rise faster than wages over a prolonged period of time without severe repurcussions. Wages in the GTA, for example, have actually declined from 2001 to 2006 after adjusting for inflation!! Yet home prices have increased dramatically in that same period of time. When this happens, exotic mortgage products are needed to fuel artificial (or unsustainable) demand and the price increases are just an elegant pyramid scheme. Another huge factor is the own/rent ratio which is also massively skewed in favor of renting for people currently with no skin in the game.
    There are many more, but for now I think I have made my point.
    Like I said, i really wish you and dan were “the norm”, but sadly, I don’t think that is true by a longshot.

  8. Thanks to all for your perspectives…
    Hi FP:
    * 40-year ams. generally don’t entail higher interest rates. Although they do entail 0.60% higher premiums on insured mortgages.
    * Recent CMHC stats suggest 45% of Canadians make accelerated weekly or accelerated bi-weekly payments. We don’t have stats on how many make lump-sum pre-payments. Combined it’s possible that the majority of Canadians do make prepayments. Mr. Vukanovich is in a good position to know.
    The previous references might have been limited to lump-sum pre-payments.
    * We’ve emailed Typepad to ask about adding an email subscription feature. Thanks for the suggestion. If it’s possible, we’ll definitely do it.
    Hello Dan:
    * Mortgage planners do not get paid more for setting someone’s amortization at 40 years.
    Hi TB:
    * First off, thank you for your viewpoints. They are critical, but they are honest, and always appreciated.
    * The mortgage industry offers countless ways for homeowners to save interest, and we tell people about these options every day. The fact is, people are more interested in finding ways to afford more house than save more interest.
    Mortgage planners have become trusted advisors and our job is to counsel clients with their best interests at heart. If a client wants 40-year 100% financing we can only show him or her the effects of this decision. At days end, it is the client’s choice and not the industry compelling them.
    * Regarding “the party” ending, with or without 40-year ams. the housing market was destined to correct. All economic cycles correct. All demand is unsustainable at the “top,” and it always will be. If 40-year mortgages keep the engine running just a bit longer, it’s an unavoidable effect. Maybe in 15 years, at the top of the next real-estate cycle, another product will fuel demand. Maybe we’ll have interest-only 100% financing by then, supply and demand will reach a long-term equilibrium, and this debate will finally arrive at its conclusion…
    All the best,

  9. Rob,
    Thank you for your detailed and well-thought out reply. It is a very refreshing viewpoint that you expressed. Once again I’ll say that in my experience, your response and honesty are also unfortunately the exception rather than the rule in your industry. People in positions of authority (in this case agents, brokers, lenders, etc) should be held to the highest ethical standard since they are dealing with what is arguably the biggest financial decision in your client’s lives.
    Sites like this and people like you should be more mainstream, and I feel many of your colleagues could learn from.
    I definitely plan to stay tuned and follow your site. It is a site that presents facts and data in addition to opinion, thus allowing your readers to discuss and draw their own conclusions. It is also, IMHO, decidedly less biased in favor of the typical ‘buy now or be priced out forever’ mantra so often pushed by many of your industry colleagues.
    You have my thanks and appreciation in this respect.

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