Why is this different in Canada and USA?
It's surreal to me the rates you can get locked in for 25 years in the US. Seems like the lender is taking a lot of risk there. When I first got my mortgage in Canada RBC offered me something like ~2% fixed on a 5 year term or ~8% fixed for a 25 year term. I can't imagine what their 25 year term rate is right now.
The bank's plan is that they will sell the mortgage before the paint drys; then they don't care what happens. Regardless, the expectation is that your mother will continue making payments until either she or her estate sell the house, at which point the full balance of the loan will be repayed without any early payment penalty.
Nobody thinks an 80yo will live another 30 years btw. Queen Elizabeth is 96 but her chances of writing herself a letter are actually not even half, since annual attrition at that age is something like 20 or 30 percent. Sorry to be a downer, I don't mean to be cynical about your mom, just looking at statistics.
The bank is taking a risk though, even if they did get recover with the estate, that's got to be a pain in the ass. I wonder at what point the administrative cost of getting that house resold doesn't make sense.
In the USA there are statutory bodies that do that. In a free market there would be no liquidity.
And it turns out that Fannie and Freddie will not back loans that involve balloon payments. Banks want to make loans that Fannie and Freddie will back, because that basically takes away all their risk. To figure out why this is a problem for shorter loan terms, we have to look at monthly mortgage payments. Here's what US fixed mortgages look like right now (quick glance at bankrate.com), with monthly payments assuming you're taking a $500k loan:
Term Rate Payment
30Y 5.54% $2850
15Y 4.75% $3890
10Y 4.67% $5220
1. As the term drops, the interest rate does not drop proportionally. 30Y -> 15Y is a 50% drop in term, but only a 14% drop in interest rate. 15Y -> 10Y is a 33% drop in term, but only a tiny 1.6% drop in interest rate.
2. Look at how those monthly payments go up! And we've only gone down to a 10Y term, whereas, from what I understand, Canada's look more like 5Y. So even if we're "generous", and say that going from 10Y to 5Y gives you an interest rate of 4.25%, your monthly payment goes up to around $9260! How many people in the US could afford a $9k monthly mortgage payment on a $625k home (assuming 20% down payment, which is standard in the US)?
Canada solves this with a balloon payment. If you're Canadian I assume you know this already, but for everyone else: essentially, for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above. And then, near the end of the loan term, you make up for it with a giant "balloon" payment. Americans are conditioned to think this is scary, but in practice, what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term. (I've gotten this from a random discussion on HN, not my own research, so please correct me if I've gotten anything wrong here.)
And, as I said, this can't work in the US because Fannie and Freddie won't back loans that include balloon payments, so banks don't generally offer them. Many do offer 15Y and 10Y fixed-rate mortgages, but they have much higher monthly payments, so most borrowers stick with the 30Y mortgage, especially when interest rates are at their lowest, like they have been for the past decade+.
The alternative in the US is the adjustable-rate mortgage (ARM), usually offered as a 5/1 or 7/1. It's a 30-year mortgage where you get a fixed rate for 5 (or 7) years, and then your rate is adjusted to market rates every year for the next 25 (or 23) years. The interest rates are even lower; for example, the 5/1 ARM is at 3.91% right now, so the monthly payment ($2360 for our $500k loan) is lower than even the 30Y fixed. But many people view them as risky, and like the comfort in knowing that their interest rate will be locked in for 30 years, even if it's a little higher. Given that rates are going up now, though, I expect ARMs will become more popular, as people will predict/hope that rates will be lower in 5 (or 7) years, and they can refinance with a 30Y fixed -- or another ARM, if rates haven't gone down much, or, worse, have gone up.
This doesn't sound like a solution at all, just a way to prevent actual homeownership and assuring all your residents will be debtors and essentially, renting their domicile, for life.
I don't live in Canada, not sure if you are right or wrong, but your claim is the exact opposite of the OP:
what happens in Canada at the end of the loan term is that the homeowner either sells the house and moves (and thus pays off the remainder of the mortgage with proceeds from the home sale, before starting a new 5-year loan term in their new home), or they refinance and start a new loan term.
> or they refinance and start a new loan term
I guess that may be ambiguous depending on where you are from, but where I live, the normal interpretation of "refinancing a mortgage" is to get a new mortgage for the principal remaining on your old mortgage, and pay off the old one with it. The new mortgage is for a smaller loan amount than the old one.
Yes, some people do take the opportunity to cash out some of their existing equity, but I don't think that's the most common thing. So yes, you do eventually own the home outright.
if there's a huge balloon payment owed at the end, then the Canadian "homeowner" still owes a large amount after 25 or 30 years. So perhaps the next loan is for less, but still a significant amount. In the US, most people do complete their 30 year mortgage and the home really is paid off, although they continue to owe property tax.
> a Canadian mortgage, your monthly payment is much lower than the numbers calculated above.
...which is why Canadian real estate is insanely expensive, even worse than the US. Buyers think monthly payment. If you lower the monthly payment, by whatever means -- extending the life of the loan, reducing interest rates, deferring principal, etc -- prices will rise. If Canadian mortgages have artificially low interest rates due to short-term rate resets AND defer principal to a balloon payment at the end, it's no surprise that Vancouver, Toronto, etc have become entirely unaffordable.
There's no difference.
A (first-time) Canadian homebuyer will typically take out a mortgage with an effective 25y amortization term over a 5y locked-in rate. At the end of the 5y, the homeowner who doesn't move will typically "renew" their mortgage for a 20y amortization term at the then-prevailing 5y fixed rate. If rates remain constant, then their monthly payment will be essentially unchanged.
A (first-time) American homebuyer will typically take out a 30y fixed mortgage, with a 30y fixed rate and a 30y amortization period. At the end of 5 years, there is no paperwork to fill out but the mortgage will now have 25y left on its amortization, and the monthly payments will be unchanged.
The main difference is that the US mortgage has a great deal of optionality built-in. An American homeowner can typically prepay the mortgage at any time without penalty, and the most common reasons to do so are to move or to refinance when rates are lower. The Canadian homeowner typically faces a prepayment penalty if they try to refinance before the end of their term.
for nearly all of the term of a Canadian mortgage, your monthly payment is much lower than the numbers calculated above
So how can a Canadian mortgage (or series of them in 5 year increments) be paid off in 30 years just like a US mortgage, if the monthly payments are much less each month?
When you presented your US numbers above, your "X year US mortgage" both fixed the interest rate for X years and set the amortization period as X years.
Canadian mortgages don't do that. Canadian mortgages fix the interest rate for X years, but the payments are set for a Y-year amortization schedule (Y>X).
If you go to a US banker and ask for a 5-year mortgage, they'll think you want your house paid off entirely at the end of 5 years, and you'll pay a hefty portion of the principal each month. If you walk into a Canadian bank with the same request, they'll be happy to quote you 5-year mortgages with an arbitrary amortization period in the 5-25 year range.
The risk for the Canadian borrower is that rates might go up significantly in 5 years, while the American lender is taking the risk that rates might go up significantly and they've got capital locked up at lower rates then what they could get.
The US has variable rate mortgages that are only fixed for, say, 5 years, but even when the minimum rate is capped just below the initial rate, they have only slightly lower initial rates than 30-year fixed rate mortgages , because while fixed rate mortgages price in interest rate risk, variable rate mortgages price in default risk (which is increased by the transfer of interest rate risk to the borrower.)
> For example, it looks like right now (just a quick Google, so maybe these are off) a 30y rate in the use is about 5.2%, while in Canada you'd be able to get around 3.9%
That's likely due to differences between Canadian and US markets other than the term for which rates are fixed, since 5/1 ARMs in the US, which aside from the interest rate lock are offered in a comparable market to US 30-year fixed mortgages, are currently at 5.04% national average.
Further, the OP made it sound like a lower monthly payment is a given. In fact, as you note, that's only true when rates are not rising. The OP (and lots of homeowners, apparently) is going to be in for a surprise as the most recent cohort of Canadian 5-year mortgages come due and get refinanced at current rates. Those payments will no longer be lower than the US equivalent who locked in a 30-year fixed rate between 2017-2021.
Thanks for the (much better) explanation.
I suspect you have a misunderstanding, presuming Canada is similar to New Zealand. In NZ, you get loan that you pay off the principal over a 25 or 30 year loan term. For the interest, you can be floating (variable interest rate) or you can lock in a fixed interest rate for a period which most people choose to be 1 or 2 years, but can be up to 5 years. Let’s say I have a 20% deposit and lock in for 5 years fixed interest[1] at 5.89%. After 5 years, the loan will revert to whatever the floating rate is in 5 years time, unless I sign up for a new fixed period interest rate (term interest up to five years, at whatever the fixed term interest rates are in 5 years). It is confusing if you come from the US because in NZ the mortgage loan term (say 30 years) is not connected to the fixed interest term (1 to 5 years) and new interest rates/terms are selected by the mortgagee whenever the previous interest term expires.
[1] https://www.westpac.co.nz/home-loans-mortgages/interest-rate...
For Canada, what I understand is that you have a 5Y (well, something between 1Y and 7Y) mortgage. The monthly payment makes it look like your amortization schedule is over 25 years, but after 5 years (or whatever 1 to 7), you'll often owe a big balloon payment, though most Canadian homeowners will end up either selling their home or refinancing at that point.
I think the closest thing to what you're talking about (in NZ) in the US is an adjustable-rate mortgage, usually offered as a "5/1" or "7/1", which means that you get a fixed rate for 5 (or 7) years, and then your rate is reset to the market rate every year thereafter (still for a total 30 year term). In practice, though, most people in the US who do ARMs choose them because they expect to sell their home in under 5 (or 7) years, or end up gambling that interest rates will be more favorable after the fixed-rate period, and can refinance with a 30-year fixed (or perhaps another 5/1 or 7/1 ARM) with a more-favorable rate.