Canada was warned its mortgage credit addiction is turning into a risk for its economy. Now the call is coming from inside the house. Well, for the house… maybe. The Office of the Superintendent of Financial Institution (OSFI) released its Annual Risk Outlook (ARO) for 2024/2025, outlining its big 4 concerns, which will set its regulatory priorities. The number one concern is mortgage credit defaults, which they expect to climb in the coming years as mortgage rates renew at non-stimulus levels.
Canada To See 76% of Mortgages Renew By 2026, 1 In 7 Of Concern
There’s been a lot of discussion on rate renewals and that’s a big concern at OSFI. They estimate 76% of mortgage debt is up for renewal by the end of 2026, as of February 2024. They warn the impact will be highest for those with significant debt, especially those who renewed at record low rates between 2020 to 2022.
The bank regulator believes variable rate mortgages with fixed payments (VRMFP) are of a “specific concern.” These are mortgages where the payment is the same for the period, but the amount applied to principal varies with changing rates. When rates went from record low stimulus levels to the highest in nearly two decades, the interest costs essentially wiped out any payment applied to the principal. As a result, many of these loans experienced negative amortization—rather than paying off the house, the term extended as the debt increased.
Sound like a dumb idea? It didn’t seem that way for a lot of Canadians, who expected rate cuts sooner. OSFI estimates roughly 1 in 7 (15%) of mortgage debt is exposed to these terms.
Canadian Mortgage Delinquencies Expected To Rise
Lenders have two major red flags when they’re assessing risk—size of debt and length carried. With mortgage lenders seeing both of those changes, it’s not surprising there’s a regulatory concern.
“We expect payment increases to lead to a higher incidence of residential mortgage loans falling into arrears or defaults,” reads the risk report.
Signs of payment stress have already been observed for those with non-performing loans. OSFI didn’t specifically share any numbers, but we’ve pulled the data from credit agencies that show a sudden “normalization” of delinquency rates after a record low. Even in supposedly hot markets like Toronto, where the delinquency rate has climbed a whopping 71% higher.
On the upside, OSFI has been one of the few regulators that have been on point with mitigating risk before it becomes a concern for the public. While higher payments might be painful, stress testing helps to ensure they can be made.
In addition, the agency has also reiterated expectations to lenders, expecting them to engage in proactive default mitigation, tighten lending standards, and set aside more capital for risk related events.
Still, regulation can only go so far with such substantial loans. The risk of borrowers facing job loss and being unable to continue to make payments still exists. Though unless they bought recently, they likely have substantial equity to cushion any downturn.
