Carolyn Rogers: Canada's mortgage market - a question of balance
Remarks by Ms Carolyn Rogers, Senior Deputy Governor of the Bank of Canada, at the
Economic Club of Canada, Toronto, Ontario, 6 November 2024.
* * *
Introduction
I'm glad to have the opportunity to speak with you today. Back in 2019, I spoke to the
Economic Club of Canada about mortgages in my previous role as a bank regulator.
Five years later I'm back, talking about mortgages again, this time from the point of view
of a central banker.
A lot has happened over the past five years, to put it mildly: we've seen a global
pandemic, the sharpest economic downturn in a century followed by the fastest
recovery on record, and a big spike in inflation.
Lately, it's been good to see inflation return to our 2% target. Monetary policy worked:
not painlessly, but it did get inflation under control without creating the sharp economic
downturn that many feared. Interest rates have started to come down, and we have the
prospect of further normalization ahead.
And yet, for many Canadians, things don't feel like they are back to normal. While
inflation has returned to target, the cost of many necessities is higher than it was before
the pandemic. Wages have also increased, but for many, incomes haven't kept pace
with prices.
Housing also continues to be a big affordability challenge. This is true for people looking
to buy a home, and it's also true for renters. For those who have a mortgage, the big
worry is the interest rate they'll have to pay when they renew.
There has been a lot of focus on what's been described as the mortgage renewal wall .
More than 4 million mortgages-or about 60% of all outstanding mortgages-will renew
over the next two years. A big portion of these have not renewed since interest rates
started rising in 2022. Even with recent declines in interest rates, most of those
borrowers will likely face a significant increase in their payment. At the Bank of Canada,
we've done a lot of work to understand the risks around the rollover of these mortgages
from a couple of perspectives.
Higher payments could cause households to pull back on spending by more than we
expect, slowing the economy. They could also lead to financial stress for borrowers and
losses for lenders and mortgage insurers. And since many mortgages are
securitizedbundled together and sold to investors-widespread losses in the mortgage market could
also have implications for market liquidity and overall financial stability. Further, since
mortgage insurance in Canada is backed by the federal government, large losses could
have fiscal implications.
That's a lot of doom and gloom, so let me be clear that these are tail risks-they're not
our forecast.
From a monetary policy perspective, our forecast includes the expectation that
households will continue to adjust their saving and spending patterns to absorb the
impact of higher mortgage payments. And as interest rates come down that impact will
fade, and consumption will gradually pick up.
From a financial stability perspective, Canadians have a long history of paying their
mortgages. Even through the 2008-09 global financial crisis, Canada never saw a
mortgage arrears rate above 0.5%. More recently, our mortgage market has fared well
through a period of economic turbulence and a sharp rise in interest rates. Arrears rates
have risen but remain near historically low levels.
Given our recent experience, it's a good time to reflect. And even if the economy is
getting back to something approaching normal, we're still expecting a future with more
economic volatility and generally higher interest rates than we saw over much of the
past two decades.
Another reason it's a good time to reflect is that mortgage finance rules are one of the
levers policy-makers sometimes use to deal with housing affordability. House prices are
primarily a function of the balance between supply and demand. But since most people
borrow to buy a house, prices are also affected by the cost and availability of housing
credit. The cost and availability of housing credit are, of course, influenced by central
bank policy rates. They're also influenced by government policy and regulations.
So this is what I'm going to talk about today. I'll start with a few key concepts to make
sure we're all on the same page. Then I'll offer a brief history lesson covering some
important policy changes in Canada's mortgage market. Finally, I will draw out a few
comparisons of mortgage finance in jurisdictions that do things differently than we do.
The objective is to see what we can learn and where there might be opportunities for
change.
Mortgages 101
Home ownership is widely considered to be good for society, so governments in most
countries like to provide incentives for it by ensuring that housing credit is available and
affordable. At the same time, mortgages are the largest debt most people will take on in
their lifetime, so governments also like to put laws in place to protect consumers and to
make sure they understand the risks that go with mortgages.
And bank regulators pay close attention to mortgages because they often represent a
big portion of the assets in the banking sector. In Canada, residential mortgages make
up about half the banking system's assets, so keeping mortgages safe keeps our banks
safe. And a safe banking sector is a precondition for a stable economy.
The policy objectives of governments and regulators can shift over time in response to
changing conditions. As policies shift, so do the balance and distribution of risks. To
understand this, it's helpful to keep in mind some basics of how mortgages work and
who the different stakeholders are.
A mortgage is simply a contract with a set of conditions that prescribe the obligations of
both the lender and borrower-things like the interest rate, the term, the amortization
period and the payment schedule.
Once a mortgage is originated, the lender sometimes retains it as an asset or an
investment. Other times they turn it into a security and sell it to an investor. If the lender
doesn't sell the mortgage, they need to fund it. To reduce interest rate risk, they will
want to fund it with a deposit that is about the same size and duration as the term of the
mortgage.
Lenders sell mortgages so that they have a variety of funding sources and don't find
themselves constrained by the availability of the deposits they hold. So investors play
an important role because they give lenders access to pools of capital that let them fund
more mortgages.
Whatever your policy objective, when you make changes to the mortgage market, it's
important to keep these three groups-borrowers, lenders and investors-in mind. You
need all three to have a healthy, functioning mortgage market.
The challenge, of course, is that how you view a change will depend on whether you're
a borrower, a lender or an investor. And sometimes, an attempt to improve conditions
for one can negatively impact another. Borrowers want affordability and investors want
an acceptable risk-adjusted rate of return. Features that reduce risk or flexibility for the
borrower can increase risk or flexibility for the lender or investor and vice versa.
The bottom line is that the mortgage market is a careful balance between a variety of
policy objectives and a range of stakeholders. To illustrate how this balance has
evolved over time in Canada, let me take a few minutes to walk you through a short
history of changes to our mortgage market.
A history of choices
Government involvement in Canada's housing finance market can be traced all the way
back to Confederation. Very few Canadians had a mortgage then. Those who did
needed a 50% down payment, and their options were generally limited to five-year
loans. Insurance and trust companies were the primary lenders, and the government's
role was limited to setting out general rules for lending.
One example is the Interest Act- a law that dates to the 1880s and is still on the books
today, continuing to shape the mortgage market in Canada. I will come back to this
point a little later.
Starting in the 1930s, the federal government began to get more involved in the
mortgage market. The motivation at that time was to boost the economy, so policies
were targeted at housing construction. After the Second World War, there was a
shortage of homes for returning veterans, so the government created an organization
called Wartime Housing Limited to provide mortgage funding at favourable interest
rates. Wartime Housing Limited would go on to become the Canada Mortgage and
Housing Corporation (CMHC), and in 1954, the government passed the National
Housing Act, enabling CMHC to insure mortgages against borrower default.
Government-backed mortgage insurance has been foundational to housing finance in
Canada ever since.1
Over the years, the features of mortgage insurance have varied significantly. Down
payments have ranged from 0% to 25%, and maximum amortizations have ranged from
25 to 40 years. In the early days, only new homes were eligible, interest rates were
capped, and the minimum term was 25 years. In the late 1960s, existing homes
became eligible, interest rate caps were lifted, and shorter terms were introduced.
These changes helped draw banks into the mortgage-lending business.
Another significant change came in 1987 with the introduction of the National Housing
Act mortgage-backed securities (NHA MBS) program. This was followed in 2001 by the
Canada Mortgage Bond (CMB) program. Both programs were aimed at making more
funding available for mortgage lending by expanding the secondary investment market
for mortgages.
Investors in both programs benefit from the fact that all the underlying mortgages are
2
insured, and that the insurance is backed by the federal government. This helps attract
a deep pool of investors and makes funding available to lenders at rates close to those
at which the federal government borrows at. By reducing the cost of funding for lenders,
these programs contribute to lowering mortgage costs for borrowers.
The next set of major policy changes in Canada followed the 2008 mortgage meltdown
in the United States and the ensuing global financial crisis. The government introduced
changes aimed at reducing risks that had built up in the financial sector during a period
of expanding access to credit and mortgage insurance. A cap on the price of a house
eligible for mortgage insurance and stricter underwriting requirements, like the stress
test, were introduced.
These same events led to increased regulation for uninsured mortgages. In 2012, the
Office of the Superintendent of Financial Institutions (OSFI) released Guideline B-20,
setting out tighter expectations for mortgage underwriting and risk management for
banks. And in 2018 OSFI added a stress test to Guideline B-20, similar to the one
required for insured mortgages.
During the COVID-19 pandemic, further changes to the insured mortgage stress test
and to Guideline B-20 were made to ensure underwriting standards remained strong
during a period of major economic upheaval and emergency-low interest rates. And
finally, most recently, the government adjusted mortgage insurance rules to provide
added support for borrowers facing affordability challenges, and OSFI has signalled a
further review of Guideline B-20.
So that's a bit of the history of Canada's mortgage market. It gives you a sense of how
changes to policy objectives over the years have shifted the distribution and balance of
risks and shaped the market we have today. Now, let's see what we can learn from how
other countries deal with similar objectives and challenges.
Do other countries do it better?
The recent focus on the mortgage renewal wall has people talking about the United
States, where 30-year mortgage terms are common. Imagine having locked in a
30year mortgage rate in the last couple of years, when rates were at rock-bottom levels.
Sounds pretty good, doesn't it?
But if you're a lender or a mortgage investor, it might not sound quite as good. The
interest rate risk has shifted from the borrower to you. And we saw a few US banks fail
in recent years when they mismanaged their interest rate risk. The 30-year mortgage
has been a feature in the United States for a long time, though, so banks have had
plenty of time to adapt their risk management and the vast majority do a good job.
One way US lenders manage risks is by securitizing most of their mortgage loans. As a
result, unlike Canadian banks, US banks don't hold most of the mortgages they write on
their balance sheet. This is a feature of the US market that is generally thought to have
contributed to the mortgage meltdown in 2008. Since US lenders didn't retain the
mortgages they wrote, they had less incentive to maintain good underwriting standards.
Government-backed mortgage insurance is also a feature in the United States. While
it's not required on high-ratio mortgages the way it is here, many lenders make it a
condition of approval. Caps on loan amounts for insurance eligibility exist in the United
States but are set according to local market conditions.
US borrowers also pay higher interest rates on their mortgages. Canadian fixed-rate
mortgages are generally benchmarked off 5-year government bond yields, whereas the
US benchmark is the 10-year Treasury.
Prepayment penalties are more restrictive in the United States, but other flexibilities are
also limited. US mortgages aren't portable, for example. So if you have a low mortgage
rate but you get offered a job in another city with a big raise, you may have to give up
your mortgage rate to get that raise.
At the other end of the spectrum, in countries like Australia and Norway, most
mortgages have a variable interest rate. This leaves all the interest rate risk with the
borrower.
Amortization periods in most countries range between 20 and 40 years, although a
fewprimarily in Europe-have 50- and 60-year mortgages and some countries even feature
100-year mortgages, designed to be intergenerational.
Interest-only mortgages are relatively common, especially in countries where interest is
tax-deductible, such as Denmark, Norway and the Netherlands.
And finally, flexibility options have become increasingly common in most countries in
recent years. Here, I'm referring to options like skipping or adding a payment or
features like a home equity credit line, which lets borrowers draw against their equity on
demand. The exception is the United States, where mortgage flexibility was significantly
Dodd-Frank Wall Street Reform and Consumer Protection Act
curtailed in the that came
into force after the global financial crisis.
There's no free lunch
So what lessons can we learn from this trip through history and around the world of
mortgages? Let me suggest a few.
One is that Canada's mortgage rules have changed over the years for all kinds of
reasons, from encouraging housing construction and home ownership, to deepening
the pool of investors, to curtailing risk and making the financial system more stable.
Many different motivations have led to the mortgage market we know today.
These changes have had important implications for the distribution of risks. Today,
about one in four mortgages is insured at origination and about $590 billion-or about
one-quarter of Canada's $2.4 trillion in outstanding mortgage debt-is backed by the
federal government. It's not hard to see why a sound, well-functioning housing finance
market is critical to Canada's economy.
Another lesson is that policy changes introduce trade-offs. There's no free lunch. Steps
to reduce the short-term cost of mortgages for borrowers can increase their long-term
costs. A quick calculation using current interest rates and the average mortgage size in
Canada shows that a borrower who stretches their amortization from 25 to 30 years can
reduce their payment by $200 per month. But they will pay their lender an additional
$50,000 in interest costs over the life of their mortgage.
And while longer amortizations and smaller down payments will increase returns for
lenders, they also increase risk for both the lender and the borrower because they
reduce a buffer that can be used if a borrower runs into stress. Regulators may adjust
to this risk by expecting more capital, and investors may adjust by expecting higher
returns. This increases the cost for lenders, and that cost often gets passed on to the
borrower in the form of higher interest rates.
Now, let's come back to the mortgage renewal wall that I talked about at the beginning
of my speech. It provides a great example of how the mortgage market is shaped by
policy choices.
In Canada, a typical mortgage is amortized over 25 years with a five-year term. This
means the borrower will confront interest rate risk four times over the life of the
mortgage, each time they renew their loan. In between renewals, the lender holds the
interest rate risk, unless they sell the mortgage.
The prevalence of the five-year mortgage is due, in large part, to the Interest Act that I
mentioned earlier, the one dating back to the 1880s. It states that a borrower that takes
out a mortgage with a term of more than five years has the right to repay the loan in full
after five years, subject to a maximum penalty of three months' interest. However, for
the first five years of a mortgage there is no limit, so most lenders charge what is called
an interest rate differential penalty. Each lender calculates this penalty a bit differently,
but generally the borrower ends up paying an amount close to the interest the lender
expected to collect over the term of the mortgage.
You can see why lenders prefer to keep mortgage terms under five years. They are not
precluded from offering longer terms, and indeed some do. But since they hold more
interest rate risk, they generally charge a higher interest rate. And so far, that seems to
have limited the uptake by borrowers. In April 2021, for example, 10-year mortgages
were available in Canada with an interest rate of 3.14%, while five-year mortgages were
at 2.29%. About 80,000 borrowers opted for the five-year rate that month, while only
400 borrowers chose the 10-year term.
Since then, of course, Canadians have lived through a period of rapid interest rate
hikes. So there is reason to believe preferences may have changed. But to make longer
term mortgages more available to Canadians, policy changes may be necessary.
Conclusion
I want to conclude by making three points.
The first is that our mortgage market has, on balance, served us well across two
important dimensions: financial stability and access to affordable credit for home
ownership. Canada has one of the highest rates of home ownership and lowest levels
of mortgage default among advanced economies.3
The impact of higher interest rates has been challenging for borrowers recently and will
be challenging for many renewing their mortgage in the next two years. But policies that
discouraged too much leverage and encouraged strong, dynamic underwriting, like the
stress test, have proven effective when you look at the experience of the past couple of
years.4
Second, when it comes to the mortgage market, there's no such thing as a simple
change. The distribution of risks across the different players has many effects, including
on the cost and availability of credit and the options and flexibility available to borrowers.
And third, we need to resist the temptation to try to solve the housing affordability
challenge by tinkering too much with the mortgage market. Housing affordability is a
very real challenge to our economy. It's encouraging to see governments at all levels
focused on this challenge and being creative with the range of solutions they are
bringing forward. Ultimately, though, improved housing affordability requires a better
balance between supply and demand, and achieving this balance will take time. In the
meantime, leaning too much on measures that reduce the short-term cost of financing
could have long-term impacts on the financial health of households, the mortgage
market and the economy.
This doesn't mean change is impossible, but it does mean change needs to be
approached with care. It's always worth asking if there's room to improve, and the world
offers plenty of examples to learn from. It's a question of finding the right balance.
I would like to thank Brian Peterson and Yasuo Terajima for their help in preparing this
speech.
1
Central Mortgage and Housing Corporation was created by an act of Parliament in
1945 to succeed Wartime Housing Limited. It was renamed Canada Mortgage and
Housing Corporation in 1979.
2
Both NHA MBS and CMBs also benefit from a timely payment guarantee from CMHC
(and ultimately the federal government). Furthermore, financial institutions also use
mortgages as collateral in securitization for both covered bonds and asset-backed
commercial paper.
3
F. van Hoenselaar, B. Cournède, F. De Pace and V. Zeimann, "Mortgage finance
across OECD countries," OECD Economics Department Working Papers No. 1693
(December 2021).
4
J. S. Hartley and N. Paixão, "Mortgage stress tests and household financial resilience
under monetary policy tightening," Bank of Canada Staff Analytical Note No. 2024-25
(November 2024).