Banks face tougher rules from federal agency, worry about unintended consequences on borrowers
In an ongoing campaign to cool the mortgage market and lower consumer debt levels, the overseer of Canada's banks has recommended tighter rules to qualify for mandatory insurance on high-ratio mortgages.
Lenders would be required to include more monthly expenses such as home insurance in their calculation of applicants' available cash flow, eliminate consideration as down payment of cash received from five per cent cash-back mortgages (which make possible 100 per cent financing), and require recalculation of loan-to-value ratios upon renewal based on an updated appraisal, under draft rules proposed by the Office of the Superintendent of Financial Institutions (OSFI).
The proposals follow a string of tightening measures undertaken over the last few years in an effort to bring down consumer ratios of debt to personal disposable income. These ratios now sit close to 160 per cent, and past reports primarily blame high housing prices and low interest rates.
Previous federal measures have included lowering maximum amortization to 30 years from 40, limiting the amount of refinancing that homeowners could undertake to 85 per cent of the property value, and requiring homeowners to meet the requirements for a five-year fixed-rate mortgage to qualify for government-backed mortgage insurance. Previously, applicants needed to meet the lower requirements for a three-year mortgage.
"[The OSFI proposals]would certainly slow growth in consumer debt," says Gregory Klump, chief economist for the Canadian Real Estate Association, "although for ratios to decline outright, the most meaningful factor would ultimately be an increase in interest rates." He said first-time home buyers would feel the new measures most.
While bankers have not yet fully analyzed the proposals, they say Canadians are handling their current levels of debt just fine. "The mortgage market is operating very well in Canada," says Terry Campbell, president of the Canadian Bankers Association. "The key statistic of mortgage arrears is very, very low – less than half of one per cent."
The proposed measures require careful examination, he says. He worries about unintended consequences. One possible outcome is that requiring requalification upon renewal could impose undue costs that would be passed on to consumers, he says. He also acknowledges that a market downturn could lead to banks requiring consumers to top up their equity to qualify for a mortgage renewal. Another proposal aimed at home equity lines of credit, which would require them to be converted within five years to a mortgage with an amortization period, could drive consumers to jump from institution to institution to open new lines of credit.
Mr. Campbell says previous changes "were precise, targeted and surgical" while the current proposals seem, at first blush, "more than is necessary and appropriate" in achieving a balance. "It's really about high loan-to-value mortgages," he says. "We are all trying to allow people to get into the housing market without making it so easy that the market overheats."
So far, says Mr. Campbell, "what you have seen is a calibrated effect of taking the air out of the balloon and making sure the market doesn't overheat." For their part, he adds, "banks before, during and after the [recessionary]crisis [of 2008 and 2009]have continued to lend in a very prudent way. Our banks are in the business of making loans to people who will pay them back. They already have rigorous lending standards."
The most effective mechanism to put the brakes on rising debt would be an increase in interest rates, Mr. Klump says. With the Bank of Canada lending rate – the benchmark rate at which it lends to major financial institutions – sitting at a record low of one per cent for 18 months now, that has not looked imminent.
But on March 26, both RBC and TD Bank announced small increases on some five-year-fixed and four-year-variable rates, a sign that the mortgage price war that triggered the debt-to-savings warnings in the first place could be coming to a close. The increases followed rises in interest rates on the bond market, where many institutions raise their funds.
Responses to the OSFI proposals are due at the end of April.