Canada’s bank regulator, the Office of the Superintendent of Financial Institutions, is considering changes that it says would help banks and mortgage insurers deal with the risks posed by mortgage borrowers who are under financial stress as a result of higher interest rates.
A proposal unveiled late Tuesday afternoon by OSFI would require banks to hold more capital if their borrowers’ mortgages are negatively amortizing, meaning the borrowers’ payments are not covering all the interest they owe.
The proposal, which OSFI published for consultation, would also require mortgage insurers to beef up their capital when borrowers’ outstanding loans are underwater, a term for when a mortgage is worth more than the value of the underlying property.
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OSFI said its goal with the proposed changes “is to make sure banks and mortgage insurers are managing risks effectively.”
The regulator said it is mulling higher capital requirements to ensure banks and mortgage insurers “have adequate capital buffers to absorb risks that arise when mortgages fall into negative amortization.” The requirement related to negative amortizations would apply in cases where borrowers owe their lenders more than 65 per cent of the assessed values of their properties.
“We believe these incremental changes add necessary resilience to Canada’s mortgage finance system,” OSFI’s superintendent, Peter Routledge, said in a news release announcing the proposal.
The new rules are open for industry feedback until Sept. 1. If approved, they would be effective next year.
The bank regulator has become increasingly vocal over the past few months, as more reports have emerged about lengthening amortization periods and borrowers’ struggles with covering the interest portions of their mortgage payments.
The past year’s sharp increase in the Bank of Canada’s key interest rate, from 0.25 per cent to 4.75 per cent, has wreaked havoc on borrowers and lenders, who had been operating in an environment of low and relatively stable interest rates for more than a decade.
Every time the Bank of Canada has increased its benchmark interest rate, borrowers with variable-rate mortgages have had to pay more interest. Variable-rate borrowers with fixed monthly payments – whose amortization periods automatically extend when interest rates rise, in order to keep their monthly payments stable – have seen the lengths of their loans soar above 30 years.
That is reflected in most big Canadian banks’ residential loan portfolios. More than one-quarter of their residential loan books consisted of mortgages with amortization periods longer than 30 years at the end of April, according to regulatory filings. That share is more than double the rate in April last year.
When variable-rate borrowers’ monthly payments no longer cover the interest portions of their loans, that unpaid interest is added to their original principal. That amount grows – or negatively amortizes – as this happens.
Lengthening amortization periods and negative amortizations are not permanent solutions for borrowers. When they renew their mortgages, the amortization periods revert to their original lengths, and the borrowers are faced with much higher monthly mortgage payments.
This is the second consultation paper that OSFI has released this year in an attempt to strengthen the mortgage system. In January, the bank regulator proposed tougher lending rules that would make it even harder for borrowers to get mortgages.
Under that proposal, the regulator is considering limiting the share of highly leveraged borrowers a bank can have in its mortgage portfolio, toughening debt servicing metrics and bolstering the existing mortgage stress test – which requires buyers to show they can still make their mortgage payments if interest rates increase – for risky loans.
Rachelle Younglai