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

  1. Merix has up to a 40 year am still on all our conventional deals.
    This has been such a great niche for a lot of our originators to sell to their clients, especially those who may be in a position to need some extra cash flow in the next couple years. AKA that kid who’s going to university soon :)

  2. With other factors held equal, defaults on conventional mortgages are only marginally higher with longer amortizations.
    The losses are slightly higher too, since the 35-am guy always has less equity than a 30 of the same size would have had.
    Another question is: Are applicants for 35 year product accepted and funded at the same rate as for shorter ams, or are there higher costs due to lower acceptance and funding rates at the application stage, too?
    The danger now is that, as lenders drop out, the remaining players will see a higher volume of (marginally) lower quality applicants and, much like ING’s comment of a few weeks ago regarding stated product (was getting a “disproportionate amount of applications”), will decide it isn’t an area they want to focus on, and they won’t want to plug up their applications pipeline with others’ castoffs.

  3. When you erroneously quoted ING above, it is clear that you are confusing 35-year amortizations with “stated income” mortgages, to which the quote actually applies.

  4. Why not keep 35 yr AMs, but qualify them at 25 years? If the ratios are in line at 25 years then give the client the option of 35…

  5. Read it again Market Bull – it makes sense. Ralph stated “stated”. It is a comparable scenario.

  6. The losses are slightly higher too
    Ralph Cramdown:
    If you took the time to read you would see that 35 year amortizations apply to “conventional” mortgages only. How are the losses higher when the person has over 20% equity??
    Sorry but you don’t know what you’re talking about.
    That is reinforced when you use generalizations like “castoffs.” If you want credibility when speaking to an industry audience, be objective. Otherwise, go find a more ignorant audience that won’t hold you to any standards.

  7. Rather than asking me to school you, why don’t you think about the scenario. The borrower apparently had 20% equity, good collateral, income and credit at the time the loan was written. Some time later, the loan is in default. Either the borrower couldn’t sell to cure, he thought he’d be in a better position by allowing the bank to FC, or he was too stupid to make the economically smart decision. And you’re asserting that the bank never books losses in these scenarios?

  8. I think this change has OSFI’s fingerprints all over it (unlike CMHC, where three years of policy changes were loudly trumpeted, OSFI tends to work quietly behind the scenes).

  9. Hi R.J.,
    Thanks for the note. That’s certainly preferable to eliminating extended amortizations altogether. In fact, some in the industry have proposed that very thing.
    I remember a Genworth stat a while back which found that only 3% of borrowers with a 40-year amortization would not have qualified at a 25-year amortization. So the impact of what you propose seems reasonable.

  10. I assume that this does not affect those that are currently in a 35-year amortization when it becomes time to re-fi (or they lock in) as long as they do so with they same lender?

  11. Hi Jim,
    Renewing is generally not an issue.
    In addition, you can often switch lenders and keep your existing amortization, even if it’s over 30 years. (That said, some lenders don’t allow it and/or limit such transfers based on the loan-to-value.) You’ll want to speak with a mortgage adviser to scope out the options.
    The above transferrability assumes that your loan amount, loan-to-value, and amortization are not increasing.

  12. I am completely confused. I thought 35 year amortizations were outlawed last spring – March 31, if I recall correctly. So how can lenders sitll be offering them?

  13. Hi Mark,
    That regulation applies to new insured mortgages with less than 20% equity.
    Amortizations over 30 years are still available on:
    * Many conventional mortgages (i.e., those with a loan-to-value of 80% or less)
    * Non-prime mortgages
    * Mortgages that are renewed with the same lender
    * Mortgages that are being switched to a new lender with no increase in risk (some lenders have restrictions on this, but many don’t)

  14. Thank you, Robert. In that case, I think CIBC took advantage of the rule change to stop offering all new mortgages with 35-year amortizations, even ones with a loan-to-value of less than 80%. Either that, or the bank rep I dealt with was mistaken.

  15. One of my friends did this :
    Took a mortgage 5 years ago with 40 years amortization, now he has 7 years remaining if he doesn’t double up his payments. And as he does pay double every time, if all goes as planned for him, he’ll be done in less than 4 years from now.
    Just an example how NOT all people that took 40 years amortization because they couldn’t qualify for 25 at the time are bad borrowers.

  16. Nobody’s saying they’re ALL bad, just that more of them go bad, statistically, than shorter mortgages do. Banks are good at servicing current mortgages, and not so good at working out delinquent ones. They’re comfortable with 1 or 2% delinquency, but even at 5%, they’re stressed. They just don’t have the systems to efficiently and profitably deal with large quantities of nonperforming loans. And 5% means 19 out of 20 like your friend, never missing a payment.

  17. Nice plug Rachelle ;)
    But it’s nice to offer the 40 yr am. Just wish you weren’t charging CMHC on rentals 65%+ LTV or we would do more rental business through Merix

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