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Your mortgage and the Interest Act - consumer protection?

Michal Balog on Unsplash
Michal Balog on Unsplash

After the US “Fed” raised its lending rate by 75 basis points, their media spent a lot of time analyzing the impact on home-BUYERS. When the Bank of Canada follows suit later this week, our focus will be on buyers but also on home-OWNERS. 

The difference is not as subtle as it seems. 

Look at stories from the US, and you will invariably see charts showing the impact on homebuyers of the Fed’s hike. 

The universal assumption in those charts is of a “30-year FIXED” mortgage. 

Raised US rates impact buyers, but those buyers sleep comfortably knowing the maximum rate they will pay for 30 years. 

American homeowners will refinance from time to time during those years – but typically only if rates go down and they decide the lower rate makes the cost of refinancing worth paying.

There are many differences in the US mortgage banking industry, but one is that mortgage interest rate risk in the US is primarily borne by lenders. In Canada, it is borne by borrowers.

Our Federal “Interest Act” has a provision (s.10) that seems like a consumer protection provision. It says that mortgages with terms longer than five years have to be “open” if the borrower is a person (as opposed to a corporation). 

Obviously, if you bought your house with a 10% mortgage and five years later mortgages were available for 2%, this would indeed seem like a consumer protection law. 

Paying interest at 10% for 30 years when the going rate was 2% would be awful. That’s when Americans pay the closing costs associated with refinancing to get a lower rate.

Most Canadian homebuyers are parties to mortgage contracts with amortization periods (how long it takes to pay the mortgage in full) of 25 or 30 years but “terms” (with fixed or variable rates) of only 2, 3 or 5 years. 

There are longer terms but at higher rates given the breakage risk to the lender of s.10. We are about to determine whether s.10 is consumer protection legislation as thousands (millions?) of Canadian homeowners with 2% mortgages find out they need, thanks to s.10, to refinance in the next couple of years at 4%, 5%, ….10%. 

Some of us remember 21% mortgage rates in Canada.

Ontario’s Housing Affordability Task Force did not mention s.10. Nor did it mention that almost all Canadian mortgages are “recourse” mortgages meaning that, unlike (most) US borrowers, we can’t “throw our keys” at the lender and walk away from the debt. 

Canadian lenders can come after us forever on our promise to pay. 

The focus of “affordability” may be about to shift from afford to buy to afford to keep.