Canadian banks are seeing fewer borrowers adding unpaid interest to their mortgage balances, but lenders still have $110-billion of outstanding loans that are ballooning because the monthly payments do not cover the interest costs.
When a mortgage increases in size that way it’s known as “negative amortization.” Three of Canada’s major banks offer mortgages that permit negative amortization – a product the federal bank regulator is now calling “dangerous.”
Bank of Montreal, Toronto-Dominion Bank and Canadian Imperial Bank of Commerce had a total of $110-billion in loans in negative amortization in their fourth quarter ended Oct. 31, according to their financial results released this week.
That was down from $130-billion in the third quarter ended July 31, suggesting their borrowers were making higher monthly payments to cover their interest costs or had sold their properties and discharged their mortgages.
The negative amortization trend began last year as interest rates soared, leaving some borrowers with variable-rate mortgages facing the possibility of far higher payments. Some banks allowed their customers to keep their payments stable by reducing the amount going toward the loan principal and even not paying the interest in full.
The billions of dollars that quickly accumulated in negative amortizations has been a clear sign of the stress borrowers are facing when they are required to increase their monthly payments to get back on track with paying down their mortgages.
BMO had mortgages worth $30-billion in negative amortization in the fourth quarter, representing 20 per cent of its Canadian residential loan book, according to its financial disclosures. That is down from $32.8-billion, or 22 per cent of its portfolio, in the third quarter.
TD had mortgages worth $37.4-billion in negative amortization in the fourth quarter, accounting for 14 per cent of its portfolio and down sharply from $45.7-billion, or 18 per cent of its portfolio, in the third quarter.
And CIBC had $43-billion in negatively amortizing mortgages in the fourth quarter. That represented 16 per cent of its portfolio. In its previous quarter, it had $49.8-billion worth of such mortgages – 19 per cent of its loan book.
Royal Bank of Canada does not allow mortgages to negatively amortize.
Bank of Nova Scotia’s variable-rate products do not have fixed monthly payments for the most part, so as interest rates rise, so do payments. With a fixed monthly payment, more of the borrower’s payment goes toward interest costs and less toward the loan principal whenever interest rates rise. As a result, the amortization period lengthens.
On their respective conference calls this week, the chief risk officers of BMO, TD and CIBC said they were taking steps to reduce the number negatively amortizing loans.
BMO’s Piyush Agrawal said the bank had a “positive customer response to the outreach resulting in a reduction in mortgages and negative amortization from prior quarter.”
TD’s Ajai Bambawale said borrowers were either making lump sum payments or moving to fixed-rate mortgages.
And CIBC’s Frank Guse said 13,000 borrowers “took action to remove themselves from negative amortizing status for the most part by increasing their monthly payments.”
Variable-rate mortgages with fixed monthly payments have become problematic for the federal bank regulator, even though such products have been around for years.
“That particular product, a variable-rate product with fixed payments, is a dangerous product in our view,” Peter Routledge, head of the Office of the Superintendent of Financial Institutions, told a Senate banking committee in early November.
“While not wanting to impose a judgment on product design, we would like less of that product. We think the system would be healthier with less of that product,” he said.
The share of bank customers with amortizations greater than 30 years has been declining over the past nine months.
At BMO, the share of borrowers with longer amortizations was 27 per cent in the fourth quarter, compared with 29.8 per cent in the third quarter. At TD, it declined to 20.6 per cent from 25.7 per cent over the same period. At CIBC, it eased to 24 per cent from 27 per cent. And at RBC, it fell to 23 per cent from 24 per cent.
With a report from Stefanie Marotta