Canada's banking watchdog has highlighted the measure’s long-term risks
A surge in interest rates and higher mortgage costs over the past year have led many financial institutions to offer extended amortizations to borrowers struggling to keep up – but Canada’s banking regulator is warning that the trend could have negative consequences down the line.
Tolga Yalkin, assistant superintendent at the Office of the Superintendent of Financial Institutions (OSFI) told a C.D. Howe Institute conference earlier this month that the measure was “not without risk” because of its potential to keep borrowers in debt for longer and increase their interest rate payments.
Yalkin said the regulator was underlining the need for lenders to “proactively manage accounts, acting before borrower stress become[s] unmanageable,” in order to help preserve the stability of the banking system.
Victor Tran (pictured top), a mortgage and real estate expert with RATESDOTCA, told Canadian Mortgage Professional that while the measure was an effective short-term solution for banks and borrowers to ensure that homeowners aren’t overwhelmed by higher interest rates, financial institutions were effectively “kicking the can down the road” by extending amortizations.
“It’s a Band-Aid solution just to help out these homeowners for the time being so they don’t lose their homes,” he said. “And [it’s] good for the banks as well, because they can just continue collecting their interest and ensure that Canadians don’t default on their mortgages.
“But it’s also bad for Canadians, because they’re not paying down the principal balance at all. They’re paying interest only – so they’re essentially just paying rent to the bank.”
Lenders on the whole are also requiring Canadians to return to the original contracted amortization upon renewal, Tran added. That means an initial 25-year amortization extended to, for instance, 60 or 70 years would return to a 20-year arrangement upon renewal after five years, which would likely see a borrower’s monthly payments spike dramatically again.
“Payment will definitely be a lot higher come renewal, and whether or not the homeowner can afford that – that’s another question,” he said.
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“And if they run the risk of defaulting or not being able to afford that higher payment due to elevated rates or the shorter amortization, I would imagine lenders will probably have to make exceptions for certain cases to allow these customers to keep that extended amortization.”
Are there any other options for borrowers struggling to keep up?
Lenders and borrowers alike are facing something of a conundrum when it comes to shouldering those dramatically higher costs: while the solution may be problematic in the long run, there don’t appear to be many, if any, feasible alternatives to stave off the risk of financial difficulty and possible default.
“This is a fairly straightforward, simple solution to help homeowners right now – to ensure they don’t default on their loans and potentially go into a power of sale situation, just extend the amortization, collect interest only, and keep the payment as minimal as possible for these customers just so they have a roof over their heads,” Tran said.
Still, it’s far from an ideal solution, with those homeowners whose monthly payment is not sufficient to cover the interest component having to deal with lenders continuing to tack on the difference on top of the mortgage or principal balance.
“Their outstanding loan amount is going to continue to grow, and they’re paying interest on top of interest. So that’s extremely unfortunate,” Tran said. “Homeowners definitely need to be proactive and try to chip away at that mortgage balance if they can – [but that’s] very difficult in these trying times.” H
How worried is OSFI about the long-term risk?
OSFI’s Yalkin said the regulator was keeping a close eye on indicators of mortgage risk, noting that a big shift in the cost of borrowing was increasing risk levels over the short and long term for Canadians.
While the Canadian Bankers Association says the percentage of delinquent mortgages – those that have fallen behind payments by three months or longer – currently sits at just 0.16%, Yalkin emphasized that could change quickly.
“We take the view that we wouldn’t be doing our job as the prudential regulator if we assume past credit performance will be future,” he noted. “Low delinquency rates can quickly turn, as we saw in the US through the 2008 global financial crisis.”
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