Are Canadians paying off their mortgages faster than originally thought? A new study from CIBC finds there are $11 billion in mortgage payments made annually that aren't being accounted for by the Bank of Canada - essentially, the mortgage debt load carried by Canadians is much better than previously thought.
Good News for the Bank of Canada
The CIBC study should help lessen concerns from the Bank of Canada that consumers are taking on too much household debt. Our central bank has implemented mortgage tightening measures in recent years, including reducing the maximum amortization period from 40 years to 25 years on high-ratio mortgages.
"Canadian households did not only resist the temptation of low rates, they used those low rates to pay down debt at a pace not seen before," says Benjamin Tal, deputy chief economist at CIBC. "Despite a lethargic labour market and an unemployment rate that is still too high for the Bank of Canada's liking, debt service performance in Canada has almost never been better."
Canadians Voluntary Reducing Their Amortization Periods
Just how many Canadians are paying down their mortgage faster? Tal says between 30% and 40% of homeowners are paying them off at a quicker pace. These pre-prepayments mean 40% to 50% of homeowners will have an amortization period under 20 years. To put this into perspective, over the last 12 months, mortgage prepayments increased four times faster than new mortgage debt.
Canadian homeowners are taking advantage of record-low mortgage rates by regularly making lump-sum payments and increasing their mortgage payments. These voluntary payments are having a big impact – the average amortization period in only 20 years, rather than 25 years, according to Tal.
With a mediocre job market and stagnant wage growth, where are homeowners coming up with the extra money for pre-payments? Instead of spending on a vacation or a new wardrobe, many homeowners are forgoing these pleasures to pay down their mortgage faster.
Benefits of Paying Off Your Mortgage Sooner
We all know mortgage rates will rise eventually, but we don’t know when. Paying down your mortgage faster offers many benefits to homeowners and the Canadian economy. You don’t have to sell me on the benefits of paying down my mortgage early; I recently wrote an article for the Globe and Mail about how I’m on track to be mortgage-free by 31. By paying down your mortgage sooner, you receive a guaranteed rate of return. That’s a lot more than we can say about investing in the stock market with the TSX at an 8-month low.
With Canadians paying down their mortgages faster en masse, our mortgage market is better prepared for an eventual rate hike, as homeowners could simply extend their amortization period back to 25 years.
"Canadian households are paying back an additional $11 billion a year in principal that's not being officially recognized," says Mr. Tal. "That extra cushion is sufficient to absorb the first 100 basis point increase in the effective mortgage rate, with households simply re-amortizing to offset the payment increase."
Are We Really Paying Off Our Mortgages Sooner?
The CIBC study flies in the face of a recent CIBC poll that found Canadians believe they will be mortgage-free at age 57 – two years later than the year before. In fact, only 11% of respondents said they made an extra mortgage payment in the last year – a lot lower than Tal suggests.
Although the household debt to disposable income ratio isn’t the most accurate measure of mortgage debt, it’s hard to ignore the elephant in the room. The ratio approached a new high of 163.3% of disposable income in the second quarter, according to Statistics Canada. Furthermore, mortgage debt was up 1.4% to $1.17 trillion.
Most homeowners are responsible borrowers and use the power of leverage to build their net worth through their principal residence. Despite the record-level debt, Canadians with mortgages have significant equity in their home, averaging about 66% of the home’s value, according to Canadian Association of Accredited Mortgage Professionals (CAAMP). Canadians seem to be finding a way to make a dent in their mortgage, despite the rate borrowers are taking out mortgages.
Sean Cooper is a pension analyst by day and financial journalist by night, living in Toronto, Ontario. He is a first-time homebuyer and landlord who aspires to be mortgage-free by age 31. Follow him on Twitter @SeanCooperWrite and read his blogs and request his writing services on his personal website: http://www.seancooperwriter.com/
