Fiction

The guys running Ottawa these days can’t balance the books, have doubled the federal debt and in so doing created a tax bomb for future gens.

They will pay for that. Karma.

But the feds did not create global inflation and they didn’t prevent a real estate crash by ordering the banks to extend people’s mortgages. So stop trying to argue otherwise. It’s bogus. If you want to blame anyone, pick the banks. They created mortgages with rates that float but payments which don’t. And that’s how we got into this mess.

For decades VRMs had been a great idea. These are variable-rate mortgages the cost of which moves along with the prime rate – which in turn is dictated by the policy rate set by the Bank of Canada. Over the years, rates have drifted lower more often than they’ve risen. Spikes were short-lived. VRM borrowers generally won.

Then the bankers had a great idea, which borrowers embraced. Let the mortgage rate fluctuate, but keep the monthly payment static for the period of the loan (usually five years). So as interest rates edged lower, more of the monthly went to principal and upon renewal the remaining debt faded. Along the way families had the stability and security of a monthly obligation which never changed. Sweet.

This worked until it didn’t. In early 2022, it all came off the rails.

Ten rate hikes took the CB rate from one piddly quarter of one lowly per cent all the way to freakin’ five. VRMs swelled from 1.5% to north of six. Interest costs exploded. But while payments stayed the same (at all banks save Scotia, which – sanely – never went for static monthlies), all the money households were sending to the bank was consumed by interest. No debt repayment. Ultimately financing charges exceeded payment amounts, so the debt itself grew.

What were the lenders to do? Payments were contractually set. No increase possible. They could demand additional payments to restore debt repayment. But they did not. These were clients with secured loans, part of huge and profitable mortgage portfolios. The bankers would always be repaid. Interest was pouring in, and the principal would be retired upon renewal, or refinanced. Risk was zero, between the lender’s security and CMHC insurance, if applicable. So until rates started to fall again, it was reasonable to extend amortizations. But it was all fiction.

The regs surrounding home loans are clear. When interest rates rise or fall there’s no no impact on the amortization period borrowers originally signed up for. So a 25-year am is always a 25-year am, until you renew or refinance (or pay it down).

What does change with blended payments (interest and principal) is the pace of debt repayment. With a VRM, rising rates are deadly because, as mentioned above, financing costs surge. Principal retirement shrinks, or ends. So lenders illustrate that by showing how long it would take to pay the mortgage off if nothing changed. Hence those crazy amortizations – which are actually fictional.

The bank cop (OSFI) spells it out this way:

When lenders provide borrowers with mortgage statements they often include a hypothetical amortization period based on a number of factors, including the remaining principal, the anticipated future payments, and the current interest rate. This calculation has, for some borrowers, projected amortization periods of 70 or more years, or in some cases an infinite amortization period. These kinds of projected amortizations are not realistic and do not represent what a borrower’s actual repayment period will be. Importantly, they do not change the borrower’s contractual amortization.

The government had zippo to do with that. These ‘hypothetical’ amortizations are based on a borrower making the same static, fixed payments at the same elevated rate until the loan is paid off. But that never happens. Everybody knows the mortgage has a term (max, 5 years) at the end of which the monthly payments will bloat to reflect the current, changed rate. Or, hopefully, rates have fallen by the time. Either way, the am of 40 or 50 or 70 years disappears into the ether.

But, the rabble cries, what about Chrystia and her Mortgage Charter which told the banks they had to do this? Didn’t the feds make it all worse?

Of course. That’s what they do. But the Charter was a nothingburger. It mostly put existing banker practice into a policy the Libs tried to lay ownership to. Nothing in the Charter will become law – something the government admits. It was PR. An attempt to look like Ottawa was getting tough on the banks in order to save hapless, dumb borrowers who thought their sub-2% home loans (allowing them to spend too much) would never end.

By the way, these are the six elements of the Charter:

• Allow temporary extensions on the amortization period for mortgage holders.
• Waive fees and costs that would have otherwise been charged for mortgage relief measures.
• Exempt insured mortgage holders from re-qualifying under the stress test when switching lenders at the time of a mortgage renewal.
• Require banks to reach out to homeowners four to six months in advance of their mortgage renewal to inform them of affordability options.
• Allow borrowers to make lump sum payments to avoid negative amortization or sell their principal residence without incurring prepayment penalties.
• Waive interest on interest when mortgage relief measures result in mortgage payments that fail to cover interest payments on a loan.

The only big news here was dropping the stress test for renewers who switch lenders – completely reasonable.

So what now? Well, over $200 billion in mortgages is still barreling towards a renewal cliff later this year and in 2025. Odds are rates will double for most of them. Amortizations will reset. Monthly payments will adjust to the new level. Families will have to find cash flow to make them, use savings to pay down the principal or sell. The market may be impacted. Maybe not.

But there will be no more half-century-long amortizations you can blame. There never were.

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