Mortgage extension fix may prove costly for borrowers and banks, regulator says
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), has warned that the mortgage payment extensions currently offered to borrowers in the country are short-term solutions that will leave them in debt for longer periods.
OSFI assistant superintendent Tolga Yalkin made the remarks during a conference held by the C.D. Howe Institute on Thursday.
Yalkin explained that the move by lenders to extend amortization periods for variable-rate mortgages, to keep payments from increasing as interest rates rise, will only provide temporary relief to borrowers while pushing them deeper into debt and accruing higher interest payments.
While the majority of the big Canadian banks offer variable-rate mortgages with fixed monthly payments, rising interest rates mean that more of the borrower’s monthly payment is used to cover interest expenses, leaving less for repaying the principal.
Consequently, the amortization period is extended to keep the mortgage payment constant. Yalkin said the growth in highly leveraged borrowers has increased the risk of weaker credit performance, which could lead to more borrower defaults and broader economic uncertainty and volatility.
According to their regulatory filings, many of the big banks have seen amortization periods climb.
In January, the proportion of residential mortgages with amortization periods longer than 30 years reached 32% at the Bank of Montreal, 30% at the Canadian Imperial Bank of Commerce, 29% at Toronto-Dominion Bank, and 25% at the Royal Bank of Canada.
OSFI proposed tougher lending requirements in January that would make it more difficult to get approved for a mortgage.
Those changes, which are still being considered by the regulator, would limit the share of highly leveraged borrowers a bank can have in its mortgage portfolio, toughen debt servicing metrics, and bolster the mortgage stress test for riskier loans.
The stress test requires borrowers to prove they can make their monthly payments at interest rates at least two percentage points higher than their actual mortgage rates.
Critics have argued that these measures are overly restrictive and unwarranted, pointing out that low delinquency rates demonstrate that tighter underwriting standards are not necessary.
However, Yalkin explained that OSFI would rather be proactive in addressing potential issues, especially since arrears are a lagging indicator of risk.
“We wouldn’t be doing our job as the prudential regulator if we assume past credit performance will be future. And low delinquency rates can quickly turn, as we saw in the 2008 global financial crisis in the U.S.,” he said.
In addition to requirements measured against individual borrowers’ mortgage applications, such as the stress test, OSFI has proposed stricter requirements for a lender’s overall mortgage portfolio.
Yalkin believes this could give lenders more leeway to approve a certain number of loans that exceed any new thresholds.
The consultation period on the proposed adjustments to the regulator’s guidelines, known as B-20, ends Friday, and OSFI is planning to release a report on the feedback it has received from industry stakeholders.
“We at OSFI understand that the decisions we make around B-20 affect a large number of Canadians,” Yalkin said. “We really do believe that this early form of consultation will help us better land in an optimal place where Canadians have access to mortgages, and we continue to have a resilient lending sector.”