We see the news, we turn the page and read the next article, and nothing is thought of these concerns until renewal time….cue the scary music.  The sad reality of our current financial environment is that few will escape the impact of the changes in effect and the changes to come.  So if you didn’t read closely the first time, take note now….THIS APPLIES TO YOU!  OSFI Superintendent Peter Routledge states that the changes OSFI seeks to incorporate into home financing policy could very well mean:

1. Fewer borrowers will qualify for a mortgage with a federally regulated lender, like a bank.

As proposed, banks would potentially have to reduce how many mortgages they grant to borrowers with high ratios of debt to income (those with mortgages over 450 per cent of their income, for example).

OSFI could also put a hard limit on traditional debt ratios, which banks use to underwrite borrowers. Today, banks make exceptions for creditworthy high-debt-to-income borrowers – so long as they have significant assets or other risk mitigants. That may end or be curtailed.

On top of that, OSFI may somehow raise the minimum interest rate borrowers must prove they can afford.

2. More borrowers will pay up for non-prime mortgages

When bank credit becomes more restrictive, borrowers increasingly search out less-regulated lenders where it’s easier to get approved. That flexibility comes with higher interest rates and fees, which raise default risk for these borrowers. OSFI suggests this is an immaterial risk for the banks it regulates – but if you’re the borrower assuming this risk, it’s material.

3. It could add slight downward pressure to home prices, other things being equal

Some will argue that OSFI’s timing could exacerbate the housing sell-off. After all, home prices in many regions have fallen off a cliff, affordability is stretched with lofty interest rates and we’re likely headed into recession. We also just got a foreign-buyers ban, there’s a new anti-flipping law, federal and provincial governments have enacted a slew of new real estate-related taxes, and in February Basel III, an international regulatory framework for banks, is going to further tighten mortgage capital requirements. It’s probably fortunate that the implementation date of these changes is several months out, at least six months is my guess.

My coles notes interpretation of this all is…..  It may get harder to borrow money, but housing could be slightly more affordable (it’s hard to say this as an Albertan in BC!).  It’s important now to plan ahead (much ahead).  Seek out assistance from a reputable mortgage broker so you can look at all options available to you – you WILL want them!

osfi is at it again.

Late last week, the Office of the Superintendent for Financial Institutions (OSFI) announced it was concerned about the risks associated with the large and rising number of highly indebted borrowers, especially those with floating-rate mortgages, which stands at a record proportion of outstanding mortgage loans.

With the economy in danger of entering a recession and the Bank of Canada warning of potentially more rate hikes to counter persistent inflation, the housing market may face continued pressure in the coming months.

A record number of buyers used floating-rate debt for purchases during Canada’s pandemic-era real estate boom. Those borrowers may come under increasing strain if mortgage costs remain high. Job losses from an economic slowdown also would make it harder for people to keep up with loan payments and stay in their homes.

Superintendent of Financial Institutions Peter Routledge said a review of the country’s mortgage-underwriting rules that starts later this week would look beyond its current main measure — a stress test requiring borrowers to qualify for higher interest rates than what their banks are offering.

“The question in our minds is, is it sufficient?” Routledge said of the current stress test. “So we will look at a broader range of debt-serviceability tools, including debt-to-income constraints, debt-service constraints, as well as the current interest-rate stress test tool.”

The proposed rules⁠—subject to public consultation⁠—include loan-to-income and debt-to-income restrictions, new interest rate affordability stress tests and debt-service coverage restrictions.

Highly Indebted Borrowers

OSFI is particularly concerned about the rise in mortgage originations to households with a loan-to-income ratio of 450% or more, which the Bank of Canada has long asserted is the sector most at risk of delinquency and default. This risk has repeatedly been highlighted in the Bank’s financial risk analysis–the Governing Council’s Financial System Review. The latest report says, “Those with high debt are more vulnerable to a decline in income and will face more financial strain when they renew their mortgages at higher rates.”

This vulnerability relates to households’ ability to continue servicing their debt if incomes decline or interest rates rise without significantly reducing their consumption. The Bank staff estimate that the most highly indebted households have generally seen the smallest increases in liquid assets. At the same time, alongside higher house prices, many households have taken out sizable mortgages to purchase a house, adding to the already large share of highly indebted households.

The chart below shows that the average share of high loan-to-income borrowers before the pandemic was 23.8%. The average since the pandemic onset has risen to 33.7%.

Proposals for Comment

To date, mortgage delinquency rates at federally regulated financial institutions (FRFIs) are at a record low. The large FRFIs have worked closely with borrowers who have reached their trigger points. TD, CIBC, and BMO have allowed some negative amortizations until renewal. As a result, the proportion of their mortgages having remaining amortizations has risen sharply (see second chart below). Questions remain regarding how they will deal with this at renewal time. Will the new mortgage be amortized at 25 years at renewal, raising the monthly payments dramatically and increasing the risk of delinquency or default, especially among highly indebted households?

Earlier last week, CEOs of the Big 5 banks weighed in on vulnerable mortgage clients. None were quite as forthcoming as Scotiabank’s new President and CEO, Scott Thomson, who said the bank has about 20,000 borrowers that it considers “vulnerable.” These are borrowers with a high loan-to-value (LTV) mortgage, a low credit score, lower deposits in their checking accounts and those with home valuations that are susceptible to market conditions.

“So, as you think about the tail risk, we have about 20,000 vulnerable customers, which would be 2.5% [of the total portfolio],” he said Monday during the RBC Capital Markets Canadian Bank CEO Conference.

However, he added this represents a “manageable-type situation for us on mortgages.” Scotiabank’s floating-rate mortgages are not fixed payment. They adjust monthly payments every time the central bank changes the overnight rate.

According to Steve Huebl at Canadian Mortgage Trends,  RBC President and CEO Dave McKay said that his bank is “keeping a watchful eye on its mortgage clients, turning to AI and various types of modelling to forecast clients’ cash flow.”

“We look at incomes, we look at the stress of inflation on expenses in a household, and we monitor cash flow to interest payments, as you would in any corporation,” McKay said during the conference. “We do that [for] every single consumer in our portfolio because over 80% of our clients have their core checking and core cash management with us.”

Looking at the bank’s variable-rate mortgage portfolio, which totals between $100 and $120 billion, McKay said the bank has been able to segment that group of clients, keeping tabs on when they reach their trigger rates and when they’ll be coming up for rate resets in the next several years.

Through modelling, the bank can then predict which clients with upcoming renewals “will or will not have a cash flow challenge” should the economy enter a moderate or severe recession, he said. “We have a pretty clear view of that.”

For clients who have difficulties making their payments, mortgage lenders have several options to try and assist borrowers before the situation progresses to the point of them needing to sell their homes.

“You have skip-a-payment deferrals, you have maturity extensions, whatever it happens to be, you have a lot of ways to work with that client,” McKay said.

In terms of clients with cash flow challenges in addition to a collateral problem, where the property sale wouldn’t cover their mortgage and could result in default, McKay said it’s a much smaller group but one the bank is actively monitoring.

“That bucket, I can tell you, is in the low single-digit percentages of our portfolio,” he said. “And that’s the bucket we’re managing.”

Bottom Line

To the extent these measures are implemented, further pressure on mortgage growth is likely. Mortgage brokers can access lenders not impacted by OSFI B-20 rule changes. More than ever, brokers could add value to borrowers turned away from the banks. In these uncertain times, existing and new clients need advice from a trained and caring professional.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Here’s the reality folks….we are in unusual times and NO ONE definitively knows what to do! We can share what we learn from analysts and economists, factor in what projections the Bank of Canada has made and analyze your circumstances to assess what options might accommodate you best. But at the end of the day, you, as the consumer need to understand where you are at to determine where you want to go when you come to a crossroads. It’s way easier (and less stressful) to be proactive than reactive!

Static variable mortgage vs non static variable mortgage (or adjustable rate mortgage)?

A static variable mortgage means your monthly payment stays the same despite interest rate increases, but the bank puts more of your money towards interest and less towards the principal. As a result the amortization of the mortgage increases. A non static variable mortgage means that the bank adjusts your payment to reflect the increased interest required by increased interest rates. As a result, amortization remains stable.

Trigger rate and trigger point?

If you hold a static variable rate mortgage, you need to know what these terms mean. You’ve reached the ‘Trigger Rate’ when the interest rate rises to the point that the entire fixed payment is 100% interest. You’ve hit the “Trigger Point” when your principal debt has crept back up to its original level, or higher as a result of making interest only payments for a long period.

OMG I have a variable rate mortgage, what do I do?

The good news is you have options. Everyone’s options will look different depending on what their circumstances are and what their capacity for payments is and what their risk tolerance is. A good mortgage broker will look closely at your entire financial landscape and see options outside the traditional boxed ones every broker is writing about.

I am in a fixed rate mortgage, none of this applies to me right?

(Cue buzzer sound) WRONG. If you’re a homeowner you will have to renew at some point. You should have a mortgage review done, re-visit your current budget (as everyone’s has changed post pandemic), and explore all the options available to you so you can be proactive and prepared so you can make education decisions with confidence (or at least some sense of faith).

Geez, what should I do?

Easy! 1. Check what mortgage product you are in. 2. If you are in a static variable mortgage ask how your lender manages trigger rate and trigger point. 3. Talk to a mortgage broker to assess your options. Your lender can only offer their own products and rates. I have access to 90+ lenders. It costs you ZERO to do a mortgage review and might save your family $000’s!