Thursday, January 30, 2014
The housing finance market is very different up north:
The standard mortgage in Canada isn't the 30-year fixed, as it is in the U.S., but a five-year mortgage amortized over 25 years. That means the loan balance has to be refinanced at the end of five years, exposing the borrower to any increase in rates that has occurred in the interim. Prepayment penalties for borrowers hoping to exploit a decline in rates, on the other hand, are very steep.
This looks as if it's a clear win for banks, which are minimally exposed to increased rates and protected from prepayments. But Canadian mortgages are also portable -- if you move before the five-year term is up you can apply your old mortgage to your new home. (If it's a more expensive home, you take out a new loan for the excess.) That restores some of the balance in the borrower's favor.
More important, observed Canadian economists Arthur Donner and Douglas Peters in a 2012 report for the Pew Charitable Trusts, the short term of Canadian mortgages allowed them to be funded from local short-term bank deposits at retail bank branches. The mortgage-lending system in Canada to this day resembles the American banking system up to the 1970s, when deregulation took hold and placed fancy, risky and careless lending at the center of the business model. (By the way, mortgage interest isn't tax-deductible in Canada, so there's no incentive to over-borrow.)