Renewal risk: The case for the 10-year mortgage

Mortgage broker Bruce Joseph is big on 10-year terms for his clients, but not to protect them against rising interest rates.

"I'm not actually concerned that interest rates are going to go up, but I do have a serious concern about a kind of risk nobody's talking about, which is renewal risk," said Mr. Joseph, who is based in Barrie, Ont., an hour north of Toronto. Renewal risk, where your lender declines to automatically renew your mortgage when the term expires, is virtually non-existent today. Customers who pay on time are not bothered with questions about whether their job situation or income has changed.

Other mortgage experts dismiss the idea of renewal risk. They say it's okay to protect yourself from rising mortgage payments with a 10-year mortgage, but don't do it out of fear your bank will turn nasty on you at renewal time.

Mr. Joseph's higher level of vigilance fits in with a theme of increasing uncertainty in the housing market. Sales numbers lately haven't been horrible, but neither have they suggested a return to strong sales and price gains. Meanwhile, some U.S. hedge fund managers have decided our housing market is vulnerable and are positioning their investments accordingly.

Mr. Joseph wonders how borrowers might be affected if the housing market did deteriorate, causing a drop in demand for mortgages and an increase in loan losses. For one thing, he speculates that some small alternative lenders may end up being acquired by banks or larger competitors. These small fry already operate on thin profit margins and it's questionable how viable they'd be if the market mortgage deteriorated.

Let's say the housing market is in fact weakening – not necessarily crashing or in free fall – and you have to renew your mortgage. You find out that the small lender you used before has been bought by a big bank that has no relationship with you. What's your renewal risk?

Let's be clear that you're only at risk if you made a down payment of 20 per cent or more on your home, which means mortgage default insurance wasn't required. There's little chance a lender would hassle you on renewal if your mortgage is insured by Canada Mortgage and Housing Corp. or private sector competitors.

Mr. Joseph's concern isn't that people will have to renew mortgages on homes that have fallen in value. Rather, it's that someone will have to requalify after having been hit with a drop in household income or a job loss.

A lender in this case could mitigate the increased risk of renewing this person by withholding a top rate discount or, worst case, declining to offer a mortgage.

"In an environment when banks are taking losses and [lending] volumes are way down, why would they not add in a feature to requalify for non-insured mortgages?" Mr. Joseph said.

In fact, draft regulations issued last year by the regulators at the federal Office of the Superintendent of Financial Institutions did raise the idea of lenders requalifying borrowers at renewal. The measure was left out of the final rules, but lenders can use it if they want.

"They always have the right to do that," said Rick Lunny, a financial industry consultant who previously served as a top mortgage executive at Toronto-Dominion Bank. "But it's always been felt from the public relations point of view that it's not a good approach to take if people are making their mortgage payments."

Robert McLister, a mortgage broker and editor of the Canadian Mortgage Trends blog, said renewal risk is close to nil. "I haven't come across that situation before," he said. "Basically, if people are paying as agreed, they're sent a renewal letter and they can start the negotiation process from there."

By the way, Mr. McLister sees 10-year mortgages as being appropriate only for people who have volatile incomes and want stability in their mortgages costs, who are extremely nervous about rates moving higher in the years ahead or who have an income-producing property and want to know their cash flow over the long term. He says a better choice is a five-year fixed rate mortgage, now available for 2.79 per cent.

Mr. Joseph's view on 10-year mortgages as protection from renewal risk applies particularly to people worried about losing a job or having their hours scaled back. But is it really possible lenders could get tough with people who are renewing in the future with a spotless record of paying on time?

"We're making an assumption that banks will act in two years like they're acting today," he said. "But banks aren't taking losses on their books today, and their stock prices are still flying high based on earnings from the mortgage market."

Terms and Rates: A Quick Mortgage Comparison

These numbers are based on a $300,000 mortgage amortized over 25 years and reflect the best rates available from banks and other lenders.

For more personal finance coverage, follow Rob Carrick on Twitter (@rcarrick) and Facebook (robcarrickfinance).