It’s something to keep in mind when considering suggestions that Bank of Canada Governor Stephen Poloz floated for the Canadian mortgage market in a speech earlier this week.
But if fixed long-term mortgages are such a good thing for borrowers and the economy, why have homebuyers not opted for them in the past? While lenders are usually focussed on imposing penalties or restrictions on prepayments, a 2012 paper in the journal Real Estate Economics noted that they should also recognize their benefits: namely that attractive prepayment options can attract “more creditworthy borrowers.”
The choice of a mortgage has broader impacts on labour market efficiency as well. A 2018 paper in the Journal of Money, Credit and Banking explains that fixed-rate mortgage borrowers impose a negative externality because such mortgages may “discourage borrowers from moving to other regions despite better employment opportunities.”
For the answer, one must consult Section 10 of the Interest Act, which dates to 1880. The Act imposes certain restrictions on a lender’s ability to impose penalties on borrowers should they choose to prepay or redeem a mortgage after the expiration of five years. Poloz also suggested that there may be an interest in developing a private market for mortgage-backed securities in Canada. However, Feldman says that the mismatch between the amortization period and maturity terms would expose security investors “to the risk that the mortgage might not be refinanced at maturity, leading to the need to liquidate the mortgage.” Thus, the mismatch between maturity and amortization acts as a structural constraint.