In the first installment of our series, we examined the shifting roles of key players and the legislative changes that positioned chartered banks to dominate the Canadian mortgage market. In this second and final installment, we delve deeper into the rise of banks and trusts as mortgage lenders, the emergence of the five-year mortgage as the industry standard, and the critical role of product innovation in maintaining a resilient mortgage financing system.
1970s: The emergence of the five-year mortgage standard
In 1969, a significant change in the National Housing Act (NHA) reduced the minimum term of an NHA mortgage from 25 years to 5 years, while keeping the amortization period between 25 and 40 years unchanged. This change made mortgages significantly more attractive for deposit-taking institutions, as it allowed them to better match the maturity of their liabilities with the NHA mortgage investments. The minimum term was further reduced to three years in 1978 and to one year in 1980. In 1982, NHA insurance coverage was extended to include variable-rate mortgages.
Life insurers, who had been major sources of mortgage financing, faced persistent inflationary pressures during the 1960s, particularly from the US, leading to the credit crisis of 1966. Liquidity became a major concern for insurers, who were generally restricted by legislation from directly accepting deposits. This made managing liquidity more challenging, and insurers struggled to compete with banks and trust companies on short-term mortgages due to their different liability base. Banks and trusts, with their ability to term match their assets and liabilities, became the dominant mortgage lenders, particularly as mortgage rates began to rise sharply in 1969 and 1970 after many years of stability. It was during this period (the 1970s) that the five-year mortgage became the standard.
1980s and Beyond: Innovation in the mortgage financing market
The 1980 amendments to the Bank Act allowed banks to establish subsidiaries, including mortgage loan companies. These subsidiaries could raise deposits that were exempt from reserve requirements. As Charles Freedman noted in a 1988 Bank of Canada paper, “The banks could then compete more effectively in the mortgage lending market with trust companies, whose deposits were not reservable.” Additionally, these subsidiaries allowed banks and trusts to offer multiple GICs, enabling investors to maximize CDIC (Canada Deposit Insurance Corporation) coverage.
The five-year term, recognized as the reference term under the Canada Interest Act, has consistently exposed lenders to prepayment risk for mortgages with terms exceeding five years. Borrowers could pay off the entire principal amount of the mortgage outstanding with just three months’ interest if the original term of a mortgage was greater than five years. While the Interest Act influences mortgage pricing and product offerings, the scope of these prepayment provisions have been overridden by the NHA for a significant period. [4]
While prepayment risk was a concern for lenders, the ability to manage interest rate risk emerged as a greater concern during periods of high inflation.
The five-year mortgage term became a standard in the 1970s, offering lenders a way to mitigate risks. However, the 1980s brought further innovation. By the early 1980s, most mortgage lenders began offering short-term mortgages ranging from six months to two years. Variable-rate mortgages also gained traction during this time, with some lenders offering versions where the rates adjusted frequently while the payment remained the same. Variable rate mortgages had the benefit of transferring interest rate risk almost completely to borrowers.[5] As mortgage rates peaked in 1982, some lenders even discontinued five-year terms temporarily.
Throughout the 1980s and early 1990s, most mortgage borrowers opted for terms of five years or less. Although seven-year and 10-year mortgage terms were first introduced in the mid-1980s, high and volatile interest rates in the late 1980s dampened consumer demand for these longer-term options.
Although long-term mortgages were once a feature of the market, it is unlikely we will ever return to that model unless significant changes are made to Canada’s mortgage financing system. During periods of financial stress, product innovation remains essential to balancing the needs of both borrowers and lenders.
The evolution of Canada’s mortgage market highlights the adaptability and resilience of the system in the face of shifting economic conditions and evolving consumer needs. Looking forward, continued innovation will be key to ensuring the mortgage market remains responsive to future challenges while fostering long-term stability.
[1] CMHC, Annual Report, 1956, p. 10.
[2] CMHC, Annual Report, 1957, p. 11.
[3] Under the National Housing Act (NHA), the government retains the right to determine lending terms, including the maximum interest rate that qualifies for insurance.
[4] In general, mortgages are subject to the Interest Act unless they are issued under the National Housing Act (NHA). Under the NHA, the borrower has the full right of repayment, with a three-month interest penalty, after the third year of a mortgage, regardless of term. This provision also applied to CMHC insured mortgages. I have not been able to find the date when CMHC removed this provision.
[5] During these inflationary periods with high nominal interest rates, the real value of mortgage payments is “tilted” toward the early part of the repayments schedule, which reduces the borrower’s ability to maintain a given payment schedule.
Independent Opinion
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