Canadian Mortgage Borrowers Are Too Indebted To Fail At Big Six Banks

Canadian Mortgage Borrowers Are Too Indebted To Fail At Big Six Banks

Canada’s highly indebted households are now too indebted for prudential management. After a low rate, investor-driven home buying spree, many borrowers are unable to keep up with rising rates, despite having been “stress tested” for a similar scenario. As a result, banks and regulators granted temporary extensions to the maximum period a mortgage can be repaid. The problem was supposed to be mitigated as quickly as possible, but recent bank filings show most Big Six banks have mortgages on their books with a remaining amortization that far exceeds the maximum limit. 

Canadian Mortgaged Are Limited To 25-Years

Canadian mortgages are generally limited to a maximum amortization, preventing predatory lenders from saddling households with debt and perpetually collecting interest. That maximum amortization has creeped higher over the years, but they’re generally limited to 25-year terms at Federally Regulated Financial Institutions (FRFI). According to the banks themselves, special circumstances may allow some uninsured mortgages to assume a term of 30-years.  

Despite boasting of prudential enforcement, Canada’s households became too indebted to fail. Now lenders are sitting on a significant share of mortgage with amortizations at least a decade longer than the limit.  

Canadian Banks Still Have A S!%t Ton Of Mortgages With More Than 35 Years Remaining

Despite the limit, Canada’s Big Six banks are sitting on a substantial share of loans with over 35 years remaining. Second quarter filings show over a fifth (21.3%) of BMO’s Canadian mortgage portfolio had remaining amortizations longer than 35 years. It was followed by CIBC (20%), RBC (19%), and TD (16.5%)—in that order. 

The two remaining Big Six banks had insignificant shares with such long amortizations. This is largely due to the fact that they generally don’t offer the type of mortgages that created the mess in the first place. 

Canadian Bank Regulator Fears Forcing Compliance Will Cause Defaults

The biggest driver of this trend was the brief surge in variable rate mortgages with fixed payments. Like typical variable rate mortgages, these loans see interest costs fluctuate with the overnight rate. However, rather than the payment size changin, the amount applied to interest costs shifts.

These aren’t particularly popular in Canada, but the investor surge in the 2020s helped to market these incredibly low rate loans. An unexpectedly sharp climb to interest rates shifted the share applied to principal to virtually nothing—in some cases, negative. This effectively made a portion of these loans negative amortizing, meaning the longer the loan exists, the longer it takes to pay off the loan. 

Canada’s bank regulator isn’t keen on such long terms, but they’re not thrilled about delinquencies either. As a result, OSFI has warned lenders they should work with borrowers, and adopt the shortest amortization that won’t cause hardship. Stating the issue needs to be corrected is one thing, but without any firm rules on testing these borrowers, it’s mostly just talk. 

At the same time, Canada’s policymakers are getting more comfortable with longer amortizations. Starting August 1, the tentative plan is to allow first-time buyers with high-ratio, insured mortgages to amortize mortgage on new construction for up to 30-years.  

The state-backed mortgage insurer is also planning to extend amortizations to 55-years for developers. They specify this is partially to help with default mitigation as well. 

It appears that long, predatory loans are only a theoretical problem. Maximum amortizations seem to be extended whenever there’s a need to inject more credit into the system. Canada’s prudentially managed financial system in action.