Financial consumer watchdog issues new guidelines to help support struggling borrowers

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The country’s financial consumer watchdog has issued new guidelines for lenders aimed at helping financially distressed mortgage borrowers, in part by discouraging banks from charging interest on interest when the time frame for paying off a loan is extended.

The Financial Consumer Agency of Canada issued the guidelines on Wednesday. They outline the agency’s expectations for how banks should provide support for existing residential mortgage borrowers who are facing “severe” financial challenges. The guidelines also outline processes for helping these borrowers adjust to higher costs by lengthening their amortization periods – the amounts of time they have to pay down their loans.

Spiking interest rates have put pressure on borrowers, particularly variable-rate mortgage holders, who have experienced sharp payment increases. These borrowers have had to increase their monthly payments or significantly extend their amortization periods.

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The FCAC’s guidelines apply to existing mortgage loans on the principal residences of consumers who are at risk of mortgage default in “exceptional circumstances.” This includes people facing difficulty as a result of high household indebtedness, rapid increases in interest rates and increased costs of living.

“The guideline is a response to the challenges facing homeowners with a mortgage in the current economic environment,” FCAC deputy commissioner of supervision and enforcement Frank Lofranco told reporters Wednesday. “FCAC’s research shows that homeowners with a mortgage are increasingly at risk of facing financial hardships, such as having to increase their borrowing for daily expenses or to draw on their savings.”

The FCAC initially revealed the proposed guidelines in March when it launched a consultation. It received more than 30 submissions from the industry, stakeholders and members of the public.

The watchdog emphasized that it does not endorse any particular measures for managing risky mortgage debt.

Many variable-rate mortgages have fixed monthly payments, which means that more of each payment is put toward interest as the Bank of Canada hikes interest rates. With less of each payment going toward the principal of a loan, the time it takes to pay off the mortgage is extended.

When a payment is not large enough to cover interest, the mortgage negatively amortizes, meaning the unpaid portion is added to the principal, increasing the size of the loan. When the mortgage comes up for renewal, the amortization period snaps back to its original length, boosting the monthly payment.

Toronto-Dominion Bank TD-T, Canadian Imperial Bank of Commerce CM-T and Bank of Montreal BMO-T offer products that allow variable-rate mortgages to negatively amortize. Mortgages with amortization periods longer than 30 years now account for more than a quarter of residential loan portfolios at most of Canada’s biggest banks.

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The FCAC guidelines say that lenders should work with at-risk customers to provide temporary mortgage relief. This could include waiving prepayment penalties when a borrower sells their principal residence or makes a payment to avoid negative amortization. The watchdog also says it expects lenders to implement short-term measures, such as waiving internal fees or costs for a limited time, and ensuring that no interest is charged on interest when a mortgage negatively amortizes.

The guidelines also suggest that financial institutions develop plans with customers to return amortization periods to their original lengths. The FCAC says amortization periods should be “reasonable,” and that the plans should include options for restoring the original payment terms, as well as assessments of the long-term, negative financial implications of negative amortizations for the customers.

In cases where a bank and customer agree that a negatively amortizing mortgage is the best way to help the borrower manage higher costs, the FCAC says, the extension should be for the “shortest period possible,” accounting for the borrower’s ability to restore the payment term to its original period.

Peter Routledge, the head of the Office of the Superintendent of Financial Institutions, Canada’s banking regulator, said in an interview Friday that the guidelines are the “most important regulatory initiative” to address the issue of negative amortizations, and a “potential antidote” to financial stressors that have arisen in recent years. He also said that, with the bulk of outstanding mortgages up for renewal in the next few years, some borrowers could see 50-per-cent increases to their payments when their terms end. OSFI contributed to the development of the FCAC’s policies.

Mr. Lofranco said the FCAC expects lenders to monitor risk among their customers, and to pro-actively reach out with options to help them absorb rising costs.

“The earlier the engagement by way of financial institutions and consumers, the more options consumers will have at their disposal to prepare for what may be a payment shock down the road,” he said.

The Canadian Banker Association said in a statement that lenders already work with at-risk customers by offering a range of measures to help them manage their mortgage debt. It said lenders also comply with “high standards for risk management” set by federal regulators.

“Canadian banks know the financial well-being of their clients is critically important to the individual, to the health of communities and the economy,” the statement added.