A few weeks ago, we revealed that sky-high Canadian real estate prices are supported by extended amortizations. It turns out someone else agrees—Canada’s bank regulator, the Office of the Superintendent of Financial Institutions (OSFI). In a letter to the House of Commons Standing Committee on Finance, OSFI explains that removing the ability to extend amortization could exert downward pressure on home prices. The world’s biggest real estate bubble obviously can’t allow downward pressure on prices.
Canada’s Banks Are Extending Mortgage Repayment Terms For Overleveraged Borrowers
One of the most ridiculed parts of the US housing bubble in 2006 was the proliferation of interest-only loans. How could they only be repaying the interest, and perpetually carrying a balance? In Canada, that would be considered prudent management, with many repayment terms failing to adequately cover the interest.
Earlier this year, we took a dive into Big Six bank filings and found a sharp increase in the remaining length of mortgage amortizations. Just a year ago, Big Six bank portfolios had just a point or two worth of mortgages with remaining amortizations longer than 30 years. We suggested this can artificially prop up home prices, and even drive them higher by creating moral hazard.
In Q1 2023, a significant share of Big Six portfolios had mortgages with amortizations longer than 30 years. Four of the Big Six reported at least 1 in 4 mortgages had at least 30 years remaining—BMO (32% of its portfolio), CIBC (30%), TD (29%), and RBC (27%). That’s a huge jump from just 1 or 2 points, with the remaining two banks showing no change from historic trends—emphasizing this isn’t a widespread trend, but lender specific.
Canada’s Bank Regulator Admits Extending Amortizations Helps Keep Home Prices High
OSFI agrees with the potential impact on home prices. The regulator provided a written response to the Committee, which asked if home prices would fall more or less if amortizations were being extended to accommodate the inability to carry the debt comfortably.
“Taken by itself, removing the ability to extend amortization periods could exert downward pressure on some house prices, as it reduces the options available to help some borrowers meet their financial obligations,” reads OSFIs response.
That’s a logical take. Extending repayment terms allows greater credit capacity, helping to push prices higher. The price of an asset can only rise as high as someone is willing and able to pay. A Beanie Baby worth $100 million is just a fantasy unless someone is willing to pay the price when you’re ready to sell, right?
Selling one or two $10 million homes is relatively easy, but all homes can’t sell for that price. A typical home is bought with a mortgage, and a typical family can’t afford the repayment term. They can only be pushed to their limit, and since most people don’t want to lose their home, they try to avoid being pushed to that limit.
By extending the amortizations lenders are shrinking payments at the expense of longer repayment. Anyone can repay anything over a long period of time. You might not be able to afford all of the lessons to learn about Xenu this decade, but you can sign a billion year contract and work out repayment terms.
That’s the amortization issue in a nutshell. Overleveraged borrowers, a significant share that are investors, borrowed too much for them to repay with their income level. Inefficient inventory should be reappearing on the market, but longer repayment terms lowered monthly costs. It also helps to improve investor cash flow.
Policymakers Are Creating Moral Hazard By Allowing Longer Repayment Terms
The secondary impact of this trend shouldn’t be understated—moral hazard. Risk is what keeps borrowers and lenders from engaging in bad deals that are inefficient for the market. Each time the state or a lender steps in to ensure risk doesn’t fall on the party engaged in risk, it tells them the risk isn’t real. This results in moral hazard, or the act of entering a deal in bad faith knowing the perceived risks are unlikely to materialize.
When perceived risk disappears, all heck breaks loose. Paying more than you can comfortably afford, or ensuring you don’t max out your credit, seems like a smart idea. Until you see people that engage in those risky moves being rewarded by policymakers and have zero consequences. Not only do the overleveraged borrowers feel like geniuses, those that played it safe get punished.
In the case of housing, Canada’s speculators and over leveraged borrowers win. Not being able to pay your bills didn’t result in having to trim back, instead special accommodations were made. Now they have improved cash flow, and an asset once again surging by over $10k/month.
At the same time, those that played it safe weren’t rewarded for their prudence. They’re left in a more risky situation, since they’re watching shelter costs soar. As a result, they’ll begin to engage in moral hazard—buying homes knowing the risks don’t make sense, but counting on policymakers to side with preserving home prices. It’s not a bad bet, considering many policymakers are just acting to preserve their own investments.
It’s Spelt “Extended Amortization,” But Pronounced “Investor Bailout”
The tricky part here is the narrative of helping borrowers meet their financial needs. When people hear this, they likely think of first-time buyers and families that were hit with rising rates. The reality is that most owner-occupied homes with mortgages were bought at a significantly lower price prior to 2020. The average mortgage payment is still lower than the monthly rent on a 1-bedroom apartment.
A share of recent buyers also jumped into the market and got in over their heads. They were stress tested for their loan though, and should be able to handle those higher mortgage payments. It might not be fun, but they were tested to ensure they could repay at higher interest rates.
The biggest borrower being helped by the pseudo-regulatory bailout are recent investors. Low rates helped investors capture up to 90% of new housing supply, zeroing in on the most affordable homes. Low rates also helped investors outbid first-time buyers for existing home sales, becoming a larger market share. RBC, Canada’s largest bank, even called it a “systemic issue” and “sad” state of affairs that investors are replacing first-time buyers at this scale.
These aren’t traditional real estate investors that are looking to make money on value. They’re largely speculator-landlords (speculords), that bought negative cash flow properties. Every month they top up the rent to cover the bills, a trend across Canada that’s long been the case in pricey cities like Toronto. BMO warned that investors that were cash flow negative at 1.5% mortgage rates are now deeply cash flow negative at today’s 4.5%.
That is, unless you lower the monthly payments by extending the amortizations for significantly longer. Policymakers can be generous in circumstances where they’re the ones exposed to risky speculative positions. What a coincidence, eh?
“In addition to the real estate holdings of Liberal cabinet ministers — notably including Prime Minister Justin Trudeau, Deputy Prime Minister Chrystia Freeland, Housing Minister Ahmed Hussen and cabinet ministers David Lametti and Francois-Philippe Champagne — 38 per cent of the MPs in all parties are real estate financiers or landlords.”
Extending mortgage amortizations will prevent short-term defaults, as well as give investors more time to exit holdings. It’ll come at the expense of greater moral hazard and a larger risk, that’ll be more difficult to contain and mitigate in the long run.
A once prudently regulated financial system is putting it all on the line for high home prices, smack in the middle of a housing crisis.