In May 2019, Bank of Canada governor Stephen Poloz was approaching the end of his tenure. A global pandemic was still a thing of science fiction and World Health Organization warnings, so the governor had the luxury of using his platform to focus on rounding out his legacy. He chose to talk to an audience assembled by the Canadian Credit Union Association and the Winnipeg Chamber of Commerce about mortgages. 

Specifically, Poloz nudged lenders to get more creative. He observed that Canada’s mortgage market is really a handful of regional markets that respond to their own set of variables. Yet for the most part, the only home loans that lenders put in the shop window come with five-year terms. “Many people I talk to do not know that longer-term mortgages exist,” Poloz said. 

That introduces rigidity. In effect, households are exposed to interest-rate risk every five years, shortening their planning horizons. Policymakers must contend with a big chunk of mortgages resetting every year, making it more difficult to manage financial stability. The only beneficiaries are the lenders, especially those that load up on government-backed mortgages. The lenders would say it’s a win-win, as their fat profit margins are what protect Canada from the financial crises that have afflicted so many other countries. 

“The system is not broken—it has served Canadians and financial institutions well,” Poloz said. “But we should not stop looking for improvements. And I invite all of you to join in this effort.” 

If anyone took Poloz up on his invitation, it’s not obvious in the data, as the overall duration of home loans has only shortened since 2019. The surge in terms shorter than five years suggests few borrowers were being offered an opportunity to refinance their existing mortgages at attractive longer-term rates. 

The former governor was prophetic. The post-COVID inflation surge, and the rapidity of the interest-rate increases that central banks orchestrated in response, caught households off guard. With no obvious option beyond locking in their pre-pandemic and pandemic-era mortgage rates for five years, hundreds of thousands of historically cheap mortgages are now resetting at significantly higher rates. The shock is a national talking point that could have political repercussions, according to pollster David Coletto. 

Economic repercussions are probably overblown. Bankers say their clients are avoiding default by extending their amortization periods, employment is holding up, and interest rates have peaked and are about to come down a little. 

But additional loan payments—$300, $500, $700 or whatever it turns out to be—is money that households won’t be spending on goods and services or investing in their TFSAs. The Bank of Canada said last week in its Financial Stability Report that households are “adjusting” to higher borrowing costs, in part by leaving more money in the bank and reducing discretionary spending. 

So the financial system is stable, but at the expense of economic dynamism. 

What might it be like if more of those mortgage holders had been able to borrow over terms longer than five years? It’s possible to get a glimpse of this alternate universe by peering over the border. Instead of five years, the duration of the conventional U.S. mortgage is 30 years. Instead of saving up for higher loan payments, American households are using wage gains on discretionary spending, despite sticky inflation and higher borrowing costs. As a result, the U.S. has reclaimed its spot as the world’s dominant economy. In April, the Bank of Canada raised its outlook for U.S. growth this year by a full percentage point from its January forecast. 

It’s not unusual for countries to have uniform mortgage markets. But there’s no law that says this must be so. As Jimmy Jean and Tiago Figueiredo of Desjardins show in a new report, Canada’s system is “more a matter of tradition than of reason.” 

Legislation that dates to the time of Confederation grants borrowers the right to repay their loans in full after five years without penalty, so lenders tend to protect themselves from early repayment by charging more for longer-term loans. Other conventions reinforced the ubiquity of five-year terms. 

Up until 2020, Canada Deposit Insurance Corp. guaranteed deposits only up to five-year terms, disincentivizing the longer-term deposits that banks demand to offset longer-term liabilities, according to the Desjardins report. Banks can also offset that risk by bundling home loans to create mortgage-backed bonds. That’s how U.S. banks cope with those 30-year liabilities: they effectively sell it to investors who value assets that will pay a consistent return over an extended period of time. Canada’s securitization market is much smaller, and it’s also dominated by Canada Mortgage and Housing Corp., which oversees a program that turns mortgage-backed securities into bonds. Like everyone else in the Canadian mortgage universe, CMHC tends to prefer five-year terms. 

Given all the money associated with real estate, and Bay Street’s idea of itself as a world-class financial centre, you’d think we could do better than this. The fact we haven’t suggests the banks are comfortable with the arrangement. That means policymakers will have to provide the spark. 

Jean and Figueiredo suggest rewriting the Investment Act to remove the five-year repayment risk, which might be enough to encourage bankers to develop a deeper market for mortgage-backed securities. The interest-rate shock surely will have created demand for longer durations, now that households have been reminded the hard way that interest rates go both up and down. Pension funds, which always are on the hunt for assets that offer a consistent return over longer periods, could be counted on to buy securities backed by such loans. 

As it happens, last month Finance Minister Chrystia Freeland summoned Poloz to lead a working group that will “explore how to catalyze greater domestic investment opportunities for Canada pension funds.” What’s more, “building more homes” is one of the items that Freeland asked Poloz specifically to explore. He already has one idea. 

Kevin Carmichael is The Logic’s economics columnist and editor-at-large. He has spent more than two decades covering economics, business and finance for outlets including Bloomberg News, The Globe and Mail and the Financial Post, where he also served as editor-in-chief.