Canada’s bank regulator plans to better protect the country’s financial system by limiting how much homeowners can borrow against the value of their homes.
The main target for the Office of the Superintendent of Financial Institutions is the popular readvanceable mortgage, or combined loan plan (CLP), in which a traditional mortgage is combined with a line of credit that increases in size as a customer pays down mortgage principal.
For months, the regulator has called out highly leveraged CLP borrowers for creating vulnerabilities for the financial system. The regulator considers borrowers risky if they owe their lender more than 65 per cent of the value of the home, also known as a loan-to-value (LTV) ratio.
The ratio is a key metric used to assess risk in the financial system, and an LTV above the threshold represents a level of indebtedness that could pose problems for lenders.
OSFI said the most significant concern with the CLPs is when a borrower’s home equity line of credit, or HELOC, continues to grow when the borrower’s LTV is above 65 per cent.
“Products structured in this way could lead to greater persistence of outstanding balances and increase risks to lenders and households,” OSFI said in a news release announcing the changes.
Under current rules, as soon as borrowers make a mortgage principal payment, they can immediately reborrow the same amount from their HELOC, and that HELOC can increase to as much as 65 per cent of the value of the home. The entire loan cannot exceed an LTV of 80 per cent.
OSFI’s new rule for readvanceable mortgages will not allow that reborrowing unless the entire mortgage has an LTV ratio below 65 per cent. That means that when borrowers pay down the mortgage principal, they may not be able to reborrow that amount immediately.
The mortgage industry said the changes would have little to no impact on the financial system, given that most lenders are already limiting borrowers once they reach the 65 per cent threshold.
“Today’s advisory seems to be an announcement of the way things are already generally being done at those financial institutions OSFI regulates – a public announcement of an existing best practice,” said J.P. Boutros, director of government relations at mortgage lobby group Mortgage Professionals Canada.
Rob McLister, a mortgage strategist, said any benefits to the financial system will be “virtually imperceptible.”
“The maximum loan-to-value on the revolving portion has long been 65 per cent and that’s not changing,” he said. “If someone wants to blow their brains out, max out their HELOC to 65 per cent LTV and make interest-only payments till infinity, they can still do that.”
The new rules will take effect after the next fiscal year for lenders, either in October or December of 2023, and will only apply when a borrower renews their mortgage. If home prices decline significantly, that would lead to a deterioration in a borrower’s property value and LTV ratio.
As of the end of the first quarter of this year, combined-loan products had a total value of $737-billion, according to Bank of Canada data. That accounted for 42 per cent of all residential secured lending. Highly leveraged CLP borrowers accounted for 11.5 per cent of all residential-secured lending.
OSFI also said it will boost lending requirements for mortgages with shared equity features, and for reverse mortgages.
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