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The $11 Billion In Mortgage Payments The Bank Of Canada Doesn’t Know About

An article from the Financial Post by Garry Marr

The Bank of Canada may not realize this, but Canadian mortgage debt is not nearly as bad as the central bank fears, says a leading economist.

Benjamin Tal, deputy chief economist of the Canadian Imperial Bank of Commerce says we are on a record spree in terms of paying down our mortgages earlier than anticipated and that’s improving our debt service performance.

“An important force behind the slowing pace of mortgage activity in the face of healthy unit sales is the increased propensity of Canadian borrowers to pay back principal,” says Mr. Tal, in a economic note published Wednesday.

He says 30% to 40% of Canadian households are now accelerating payments which has the effect of shortening amortization periods. The extra payments means 40% to 50% of homeowners will have an amortization period of less than 20 years.

The amortization period has long been a concern of Ottawa which has limited their length to 25 years for mortgages backed by the federal government. The maximum length was once 40 years.

Mr. Tal said that over the last 12 months principal payments rose four times faster than new mortgages. Today for every mortgage dollar taken in, 90 cents of principal is paid back.

The Bank of Canada says the debt service ratio — the cost of carrying a mortgage as a share of disposable income — is 6.3%. But he says the percentage is based on a 25-year amortization as opposed to the current pace of 20 years for most Canadians.

“Applying this amortization period to the calculations yields a mortgage debt service ratio of 7.3% — a full percentage point higher than officially stated by the Bank of Canada,” said Mr. Tal, adding that it ultimately means Canadians are paying $11-billion a year more in principal payments than the central bank has estimated.

Mr. Tal says there is no question a 200 to 300 basis point increase in rates would create not as “rosy” a picture for Canadians, but argues there is an “extra cushion” to absorb a 100 basis point increase based on current payments. Households could simply lengthen amortizations to handle the increased rates.

He adds that there has been very little change in the market, in terms of mortgages with a loan-to-value of greater than 80% which are backed by the government. He also adds the average credit score has been trending up among homeowners. The sub-prime mortgage market, people with credit scores below 620, has also remained constant at 3.5% of all new mortgages.

“So far, it appears that not only have many households resisted the temptation of low rates but, in fact, they used those rates to pay down debt at a rate not seen before,” Mr. Tal writes. “The Bank of Canada is determined to keep low rates for as long as possible, further testing the willpower of Canadians.”