Temporarily extending amortization periods has been a saving grace for many variable-rate mortgage holders as a way to manage the impact of higher interest rates and borrowing costs.
But Canada’s banking regulator says that while the strategy may be attractive, it’s also “not without risk,” since it “keep[s] borrowers in debt longer and lead[s] to higher interest payments.”
The comments were made by Tolga Yalkin, an assistant superintendent at the Office of the Superintendent of Financial Institutions (OSFI), on Thursday while speaking at the CD Howe Institute.
“Our conversations with financial institutions have emphasized proactively managing accounts, acting before borrower stress become[s] unmanageable,” Yalkin said. “We have been clear that we appreciate lenders working with clients to help them stay in their homes while ensuring actions taken remain within the institution’s risk appetite, while recognizing this can sometimes be a challenging path for lenders to navigate.”
As of the first quarter, a number of the Big 6 banks reported continued growth in the length of their clients’ amortization schedules, which is the amount of time it will take borrowers to pay off their mortgage at current payments.
Roughly one-third of BMO’s residential mortgages now have an amortization period stretching more than 30 years, up from zero a year ago. Similarly, TD reported that 27% of its residential mortgage portfolio has an amortization of more than 35 years.
In most cases, the mortgage contracts will revert to the original amortization schedule at the next term renewal, which will generally translate into higher payments.
For its part, Yalkin says OSFI has been tracking various indicators of mortgage risk for signs of borrower vulnerability.
“We’ve been seeing that the sharp change in the cost of borrowing is posing short and long-term risk to mortgage holders and lenders,” he said, noting that the growth in highly leveraged borrowers is increasing the risk of weaker credit performance.
“While lending institutions are well-capitalized and financially resilient, the higher cost of borrowing—and any potential economic downturn—could lead to more borrower defaults, potentially a disorderly market reaction, and even broader economic uncertainty and volatility,” Yalkin added.
Are OSFI’s guidelines too strict given low delinquency rates?
Yalkin addressed concerns from those who have argued OSFI’s underwriting standards may already be too restrictive given the current low delinquency rates across Canada.
The national delinquency rate, or the percentage of mortgages that are behind payments by three months or longer, currently remains just off all-time lows at 0.16% as of January, according to the Canadian Bankers Association. That’s still well below the rate of 0.27% reached in mid-2020, and rates averaging 0.45% in the years following the financial crisis.
In response, Yalkin pointed to delinquencies as being a lagging indicator. “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 said. “And, low delinquency rates can quickly turn, as we saw in the US through the 2008 global financial crisis.”
In the near term, Yalkin said risks are primarily among variable-rate mortgage holders, including those with static and adjustable payments, as well as fixed-rate holders that have a renewal coming up.
Longer-term risks OSFI is concerned about is related to the “build-up” of household indebtedness.
As part of its Annual Risk Outlook (ARO), OSFI flagged certain risks associated with the rapid rise in home prices and the growth in more highly indebted borrowers. As a result, it unveiled three proposed regulatory updates that, if implemented, could further restrict mortgage lending.
The consultation period on the proposals wrapped up today, with OSFI expected to make an announcement on its decision later in the year.