It’s no secret that Canada’s banking regulator has its sights set on fixed-payment variable-rate mortgage products. And OSFI chief Peter Routledge reiterated that point during a speech today.
Routledge said OSFI’s mortgage stress test, which ensures mortgage borrowers are able to handle higher rates by qualifying them currently at two percentage points above their contract rate, is “effective,” but “not perfect.”
“During the pandemic years, when interest rates fell to historic lows, many mortgagors took out variable-rate, fixed-payment mortgages (VFM),” he said during the Scotiabank Financials Summit.
These mortgage products, which are offered by most big banks except for Scotiabank and National Bank, keep monthly payments fixed even as interest rates fluctuate. When rates rise, as they have over the past year and a half, less of the monthly payment goes towards principal repayment and a greater portion end up going towards interest costs.
OSFI estimates that $369 billion worth of outstanding mortgages—out of a total mortgage market of $2.1 trillion—currently have fixed-payment variable-rate products. Of those, approximately $260 billion worth have seen their amortizations periods soar to 35 years or longer.
Experts have pointed out that these products have so far cushioned many variable-rate mortgage borrowers from the full impacts of the Bank of Canada’s rate hikes.
Better if VFM products are “less prevalent”
OSFI’s concern with these products, however, comes from the fact that when the term renews, the borrower will have to increase payments to bring the amortization back to its original contract schedule, as well as make up for any deferred principal paydowns in the event the borrower reached their trigger rate. In that case, 100% of their payments would have been going towards interest cost and could have resulted in negative amortization.
“This means [these borrowers] are at risk of suffering a significant payment shock,” Routledge said. “While there are ways to reduce this shock—early voluntary paydowns and refinancing, to name a few—I think the housing finance system would produce better outcomes for borrowers and lenders alike if this product was less prevalent.”
Routledge said OSFI is currently looking at “this problem” through the prism of Guideline B-20, the regulator’s mortgage underwriting guideline.
OSFI will release its findings in October
OSFI is currently conducting a comprehensive review of Guideline B-20, which Routledge said “focuses on enhancing credit quality and mortgage underwriting, expanding the scope of the guideline, and incorporating recent supervisory insights.
As part of that review, earlier this year OSFI unveiled three new regulatory proposals focused on debt serviceability
The proposed new rules, which have no undergone public consultation, include loan-to-income and debt-to-income restrictions, new interest rate affordability stress tests and debt-service coverage restrictions.
Routledge confirmed that OSFI will share the feedback it received from its industry consultation as part of its semi-annual update.
“I suggested earlier…that the mortgage stress was imperfect; perhaps it is better to call it incomplete,” Routledge said, adding that the regulator is aiming to implement “common-sense protections” that work effectively both when rates are high, as they are today, and low, as they were during the COVID pandemic.
“Our primary aim is to ensure that Canadian homeowners can afford to service their mortgages in good times and hard times,” he said. “As a secondary goal, we aim to ensure that OSFI’s measures impact our regulated constituents proportionately such that all lenders in the federal financial system, regardless of size, can compete and take reasonable risks.”