They've been popular in the United States for years, but interest-only mortgages are just now coming to Canada, after the federal housing agency announced it would provide mortgage insurance on the loans.
Canada Mortgage and Housing Corp. (CMHC) is also eliminating application fees on all high-ratio mortgage loan insurance products, and insuring extended amortization periods of up to 35 years.
"These innovative financial solutions will allow more Canadians to buy homes, and do so sooner," says Karen Kinsley, president of CMHC, in a news release. The agency says it will provide mortgage insurance "that allows lenders to offer borrowers with a proven history of managing their credit responsibly the option of making interest-only mortgage payments for up to the first 10 years when they purchase or refinance their home. This new option will give borrowers greater flexibility in managing their cash flow."
But CIBC World Markets says in a report that: "Given where we are in the mortgage cycle, it appears that the current wave of growth in mortgage outstanding is of a higher risk." It says the new mortgage products on the market in Canada "reflect a maturing and more dynamic mortgage market. But they also imply that at the margin, we will see increased default risk in the mortgage market."
Interest-only mortgages allow the borrower to make payments on the interest only, for up to the first 10 years of the mortgage. After the interest-only period, the balance is amortized the same as with traditional mortgage loans. Then principal and interest payments must be enough to ensure that the entire mortgage is paid off 25 years after the mortgage was initiated.
"Examples of borrowers who would benefit might include young people who have a good credit history, but who may prefer more cash flow flexibility with some of the up-front, one-time expenses associated with the purchase of their first home," says CMHC.
Invis , a Canadian mortgage brokerage, says that the interest-only mortgages will allow people to buy more expensive properties, and will improve their cash flow during the first five or 10 years of the mortgage, but it says borrowers must be prepared for when the regular amortization period kicks in.
"If you're considering an interest-only mortgage, it's essential to have a long-term plan in place to ensure the value gained outweighs the interest paid," says Andrew Moor, president and CEO of Invis.
The company says that to lessen the amount of interest you must pay, it's a good idea during the first 10 years of the mortgage to consider making lump sum payments to reduce the amount of mortgage principal, if your budget allows. "If you receive a raise, consider increasing the size of your monthly mortgage payments to help pay down the mortgage principal faster," Invis suggests. "If your financial circumstances allow, consider converting an interest-only mortgage to a regularly amortized mortgage -- as quickly as your budget allows."
Finally, Invis says you should make sure you understand the long-term implications of an interest-only mortgage. "Speak to a mortgage professional who can not only explain the details of this approach, but also put in place a multi-year mortgage strategy and offer ongoing advice."
The CIBC report says the recent increase in both variable and fixed-term mortgage rates "suggests that mortgage interest payments will rise in the coming few months. Overall, we expect the debt service ratio to rise to eight per cent by late 2006 -- enough to trigger an upward trend in delinquency and bankruptcy rates, but not a high enough increase to cause major bankruptcy problems."
CMHC says the elimination of application fees will result in savings of "typically $165, but up to $235 depending on the type of insurance transaction." There will be a premium surcharge for insurance of interest-only mortgages -- 0.25 per cent for a five-year interest-free term, and 0.50 for 10 years.
The extended amortization periods, designed to allow buyers to purchase a home and start growing equity sooner, carries a 0.20 per cent surcharge for a 30-year amortization and a 0.40 surcharge for a 35-year product.
The CMHC website includes a chart that shows how extending the amortization periods affects monthly payments.
