OSFI Urges Action On Canadian Mortgage Extensions Before It Becomes “Unmanageable”

Canada’s financial regulator has sounded the alarm on the mounting risks associated with mortgage extensions, urging lenders to take immediate action. Following a surprise rate hike by the Bank of Canada, many borrowers are grappling with increased mortgage costs, necessitating swift measures from financial institutions.

The Office of the Superintendent of Financial Institutions (OSFI) emphasized the pressing need to address the risk accumulation in Canadian lenders’ portfolios. With the central bank’s resumption of interest rate hikes after a four-month pause, concerns have heightened. Having reached a 22-year high of 4.75%, interest rates are expected to climb further by 25 points next month, according to analysts.

To temporarily alleviate the impact of rising borrowing costs, several major Canadian banks have allowed variable rate mortgage holders to extend their amortization periods, maintaining repayment levels. However, this approach introduces risks for borrowers in the future.

OSFI emphasizes the necessity for lenders to adopt a more prudent and active approach to account management, resolving negative amortization promptly and recognizing the elevated risk of these loans for loss provisioning.

“Our ongoing conversations with financial institutions have highlighted the importance of being proactive in managing all types of mortgage accounts, and to act before levels of borrower stress become unmanageable,” the regulator said.

The regulator had previously warned in April that while extending mortgage payment periods provided short-term relief for borrowers, it would prolong their debt burden. This warning proved valid, as data from Canada’s housing agency CMHC revealed a decline in the number of borrowers opting for variable-rate mortgages, dropping to 16.7% in January of this year from around 50% in early 2022.

As interest rates rise, mortgage payments no longer cover the interest payment portion, leading to negative amortization and an increasing mortgage balance. Desjardins analyst Royce Mendes highlights that the big six Canadian banks had over 20% of their mortgage portfolios with repayments exceeding 30 years in the first quarter, primarily due to non-amortizing variable-rate loans. This is a substantial increase from approximately 2% the previous year.

Variable-rate mortgage holders are now facing at least a 30% increase in payments to remain on their original schedule. Consequently, some borrowers might opt to extend their repayment periods. It is worth noting that the amortization is likely to be kept below 30 years.

Bank of Canada data from May indicates that approximately one-third of mortgages have experienced payment increases compared to February 2022, just before the central bank initiated its policy interest rate hikes. The central bank anticipates that nearly all mortgage holders will experience payment increases.

While major banks claim that only a few customers are choosing to extend their mortgages, analysts caution that the challenges will persist throughout the year.

“We continue to view mortgage lending as a moderate revenue headwind for Canadian banks, with added risk to the economy as mortgages renew at higher rates, pressuring disposable income,” warns KBW analyst Mike Rizvanovic.

Moreover, Canada’s largest banks have allocated additional funds to cover potential loan defaults this quarter, anticipating vulnerabilities in commercial real estate and a rise in delinquencies.

“We believe risks are still elevated, with the prospect of more rate hikes exacerbating the headwinds on mortgage renewals,” Rizvanovic adds.

In a recent survey conducted by the Canadian Imperial Bank of Commerce (CIBC), it was found that despite concerns about affordability, homeownership remains a significant goal and a source of pride for many Canadians. 

The aspiration to own a home also ranked high among non-homeowners, with 71% expressing a desire to own a property. However, concerns about inflation and rising interest rates weighed heavily on the minds of mortgage holders (82%) and renters (64%), who fretted about their ability to meet mortgage payments or keep up with rising rental costs.

Information for this story was found via Reuters and the sources mentioned. The author has no securities or affiliations related to the organizations discussed. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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