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Benefits and Pensions MonitorLong-term Mortgages – They Do Exist!
The misconception that mortgages are of short duration likely arises from the erroneous belief that long-term commercial mortgages are open to repayment by the borrower after five years. This is only true for loans written in the name of an individual, not a corporate entity. By law, these personal mortgages are open for repayment after five years. Insured and conventional longterm commercial mortgage loans are typically closed and non-repayable for the term of the loan. That is not to say that a commercial borrower cannot negotiate an early repayment. Mortgage contracts can be structured to include a clause allowing early retirement of the loan, subject to the greater of three months interest or a ‘yield maintenance’ provision. Present Value For example, if a borrower triggered an early repayment option on a mortgage with an outstanding balance of $1 million, a contract rate of 6.5 per cent, and a remaining term of 10 years, the additional yield maintenance payment, based on a Canada bond yield of 3.95 per cent, would be about $187,000. To maintain the original return for the client, the manager would simply invest the $1.2 million received in a 10- year Canada bond or, alternately, another 10-year mortgage and pick up the yield differential for the benefit of the client. Should current mortgage rates exceed the face value of the repayable mortgage, the lender would happily accept the threemonth interest penalty and reinvest all the proceeds at the higher prevailing rate.
Early Repayment Long-term, non-repayable, commercial mortgages are available to lenders for a term to maturity of up to 30 years. Yields on these loans average 120 to 165 basis points higher than an equivalent government of Canada bond, while CMHC insured loans earn a 40 to 80 basis point spread over the equivalent bond. Since monthly mortgage payments include principal and interest, a 25-year term commercial mortgage would have a duration of about nine years, roughly comparable to that of a 12-year government bond. Life insurers have used long-term mortgages for more than 50 years to offset longer-term liabilities as they offer an excellent match for products that have similar cash flow characteristics, such as annuity payments. For pension plans, long-term commercial mortgages represent an ideal asset to offset long-term liabilities by providing monthly cash flows to meet those liabilities. For most pension plans, stable monthly cash flows are just what the beneficiaries ordered. Greg Dwyer is vice-president, mortgages, at Co-operators Investment Counselling Limited. |
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