Written by 11:28 PM Opinion • 18 Comments Views: 2

Choices Shrinking for 35-Year Amortizations

35-year-amortizationsFirst National is eliminating 35-year amortizations on conventional mortgages, effective Tuesday April 3, 2012.

That is noteworthy for two reasons:

  1. First National is Canada’s 7th biggest mortgage lender and 2nd largest broker lender by market share, and
  2. It may foretell a broader trend.

First-NationalFirst National cites internal challenges and insufficient demand as reasons for its decision.

A First National spokesperson told CMT:

The 35-year conventional product had certain restrictions that created confusion. Based on that and demand, we decided to streamline our offering.

We also spoke with two other lenders to get their take.

Both executives we talked with told us the same thing: limits on bulk insurance and higher funding costs are two key reasons why amortizations over 30 years are under the gun—at least in the prime lending world.

“Heightened risk sensitivity” is a big issue, says one lender. Mortgage investors (which many smaller lenders rely on for liquidity) and default insurers are now a bit more careful with amortizations over 30 years. Some investors choose not to purchase them.

Measuring RiskDespite that, we have never heard one lender (including those we spoke with today) cite materially higher risk as a problem for extended amortization borrowers. We frequently ask that question and always get the same answer. With other factors held equal, defaults on conventional mortgages are only marginally higher with longer amortizations. Risk is more correlated with factors like repayment history, equity, employment, etc.

That said, the future of extended amortizations is growing more uncertain. Three related trends could potentially unfold through the end of this year:

  1. Well-qualified conventional borrowers who desire longer amortization for cash flow management purposes will run into limited lending options. (Smaller lenders who fund largely through deposits may be the last place left to find 35-year amortizations on prime mortgages.)
  2. If more prime lenders stop serving this niche (and we expect that may happen), lenders with competitive funding costs on extended amortization mortgages will see volumes increase—especially those with broker channels.
  3. Uninsured non-prime lenders (the Equitable Trusts of the world) will see more business, to the extent they leave 35-year amortizations in place. Of course, borrowers will pay higher rates for the privilege of these products.

Given these developments, one may wonder what utility extended amortizations provide. Some believe their primary use is to shoehorn people into homes they might otherwise not be able to afford.

While that undeniably happens in certain cases, extended amortizations have far more valid uses. Some of the many examples include freeing up cash flow to:

  • Bolster the family contingency fund (which is especially helpful for people with fluctuating income, like self-employed or commissioned borrowers)
  • Pay educational expenses
  • Pay medical expenses
  • Accomodate a personal development or care leave
  • Reduce higher interest debt
  • Pay child care expenses
  • Build a business
  • Finance value-added renovations, and
  • Invest for retirement (in a TFSA for example).

Homeowners with long-term amortizations can then prepay their mortgage when the time is right for them—which in turn can significantly reduce their actual (“effective”) payoff period.

In short, the flexibility of longer amortizations is an important economic benefit. It’s a benefit that is currently enjoyed by a meaningful number of responsible borrowers, but who knows for how much longer…

Robert McLister, CMT

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Last modified: April 29, 2014

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