MORTGAGE: Will longer amortizations be nipped in the bud?

Shannon Puddister figured he would probably need some flexibility when he took on his first mortgage, with an 18-month-old daughter already in tow and another child on the way.

The 32-year-old Toronto-based commercial litigation lawyer with Lerners LLP, bought his first home last year with his wife Deanna Webb. To deal with the financial strain of two children, they chose to amortize their mortgage payments over 30 years.

His payback plan should come as no surprise. For generations, Canadians have gone for 25-year amortizations but according to the Canadian Association of Accredited Mortgage Professionals, almost half of new borrowers now opt for a longer amortization.

"When we put together our budget, we looked at it as a cash flow issue. A longer amortization rate means a lower payment. I know that means you are paying more interest but from our perspective, entry level buyers with a kid, our plan was to get ourselves settled, push through with a first mortgage and, when we renewed our mortgage, shoot for a lower amortization," said Mr. Puddister, whose wife gave birth to their second child this month.

Just 15 months ago, he could have opted for a 40-year amortization but Ottawa cracked down on those lengths and set the limit at 35 years. The government also demanded consumers have a 5% downpayment.

Last month Finance Minister Jim Flaherty seemed to renew debate on the subject, when questioned by reporters about the booming housing market that has rebounded sharply from lows reached in January.

"Well, we have to watch and we are watching and monitoring. As you know, we took steps a year or two ago to require at least a 5% down payment and to restrict the amortization period for insured mortgages but we're watching that. Low interest rates obviously are having an effect on the strength of the housing market in Canada," he said, warning "people have to make sure that the mortgages they take out today either have a fixed rate or they know that they'll be able to handle increases in that mortgage rate later on."

In his case, Mr. Puddister says there is no question a larger downpayment or shorter amortization requirement would have changed his buying decision dramatically. The other problem is today's rates are so low, he can't see himself trying to pay down his mortgage principal any faster.

"I'd rather dump it into an investment," says Mr. Puddister, who is borrowing at about 2.25% based on today's rates.

While Mr. Puddister may have the financial discipline to save and invest the money he is saving from low interest rates, mortgage broker Vince Gaetano says he is the exception.

"Only abut 5% of people take advantage of pre-payment privileges," says Mr. Gaetano, adding once a consumer gets used to low monthly rate, they are loath to increase the payment even if it means knocking down principal faster.

"You get a mortgage for five years and then don't think about it. Are you going to start making payments or are you going to take your vacation? I don't think it would be so bad to take the maximum amortization down to 25 years because that way you would have some buffer room for making sure people qualify."

CIBC World Markets senior economist Benjamin Tal says the bigger issue for consumers would probably be an increase in downpayment as opposed to a change to amortization schedules. Even though half of mortgage origination is said to be going for a longer amortization, Mr. Tal issued his own report that shows 40% of Canadians opt to make an extra month's worth of payments each year.

Called accelerated bi-weekly payments, consumer make payments every two weeks instead of twice a month and the impact is considerable. "On a $250,00 mortgage with 5% rate amortized over 30 years, that works out to a de facto shortening of the amortization period by five years," says Mr. Tal, adding if rates rose by 75 basis points, consumers could absorb the increase by simply stopping the accelerated payments.

Mortgage credit was up about 7% year over year when Mr. Tal wrote his report but he thinks dramatic changes to downpayment levels and amortization are not necessary at this point. "Be careful you don't kill a fly with a hammer. You could derail the housing market for no good reason," says Mr. Tal.

In real estate circles, many privately grouse about Mr. Flaherty's overreaction to an improved housing market that still fell well short of records set in 2007. "You don't want to see anything that affects the ability to purchase," says Gary Friend, president of Canadian Home Builders' Association. "You make changes and in a place like Vancouver where I am, it could have a significant effect. At the same time we respect the need for prudent credit conditions and smart borrowing."

Low rates, low downpayments and long amortizations have made it easy for just about anybody to buy a home, says Ron Cirotto, who runs the website amortization.com. He sometimes wonders why everybody feels they must buy.

"What they've done with mortgages, it's almost like the concept we had when I was coaching hockey. At one point it seemed like everybody got a trophy. The finalist, the semi-finalist. Everybody has to be winner, everybody has to have house even if they can't afford it."

(prepared by Garry Marr/Financial Post)