“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.
Despite 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:
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.)
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.
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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