Canadian banks’ mortgage loan payment flexibility paying off for good-paying borrowers
Some consumers with variable-rate mortgages at Canada’s biggest banks are tacking unpaid interest onto their mortgage’s principal instead of paying the full amount each month. Others are paying interest only.
The tactics are becoming more common as borrowers try to navigate a massive surge in mortgage rates that has ramped up costs and sent house prices falling. It’s a particular issue in areas such as the U.K. and Canada where a chunk of the mortgage debt is floating rate, meaning homeowners are regularly forced to confront the reality of much higher borrowing costs. And it’s a problem skirted by consumers in the U.S., where it’s easier to snag a 30-year mortgage that has a fixed rate.
By allowing borrowers to add unpaid interest onto a loan’s principal or stop paying down the principal each month, lenders are helping to stave off defaults and any forced selling. That’s helping consumers more easily adjust to higher costs — though at some banks, there are limits.
“This is a group effort because the problem comes when panic strikes,” said Arjun Saraf, chief financial officer of New Haven Mortgage Corp., a Toronto-based private mortgage lender. “Lenders have become more flexible and are realizing that they have to do what they can to accommodate good-paying borrowers to remain in their homes.”
So far, the flexibility is paying off. Canadian home prices have slumped nearly 16 per cent and borrowing costs have nearly doubled. But mortgages in arrears, or those loans that are behind on payments by three months or more, are still only 0.16 per cent of total loans outstanding as of the end of January, according to data from the Canadian Bankers Association.
The lack of distressed sales is helping Canadian home prices find a floor. A dearth of new listings in February made the national market the tightest since April 2022, and more recent data from Toronto, Canada’s largest city, and Vancouver show prices starting to rebound with the scarcity of supply becoming even more pronounced.
“We are extending and pretending,” Steve Saretsky, a Vancouver-based real estate broker, said of the banks’ approach to their borrowers. “Banks are saying, ‘We don’t really care, just extend it — just loop it onto the balance.’ I think that’s actually depressing distressed inventory” in the housing market.
With the banks also signaling an intent to accommodate borrowers once their mortgages come up for renewal, the number of houses that would otherwise have come up for sale could be limited further. And the government may soon be stepping in to make sure they do. Last month, Canadian regulators released draft guidelines for how banks should deal with the rapid rise in borrowing costs. The proposal made explicit an expectation that lenders help mortgage holders avoid delinquency.
In a way, this flexibility is helping both sides of the system avoid bigger problems along the way. Borrowers don’t want to lose their homes, and too much inventory hitting the market all at once could sink property values further, making it harder for the banks to get their money back in the event of a default by selling the houses themselves. And the situation could also ease: Expectations are rising that the Bank of Canada will cut its benchmark rate before the start of next year.
But the longer it takes for that to happen, the higher the chance for complications. Borrowers could start to face a heavier financial burden each month as new payments are calculated based on a principal amount that’s increased. Banks, already rattled by the financial turmoil in the U.S. and Europe, could face higher costs themselves as mortgage books get riskier.
CIBC had about $52 billion worth of variable-rate mortgages, or about 20 per cent of its Canadian portfolio, where the borrower’s fixed monthly payments are no longer covering interest, as of the fiscal first quarter ended Jan. 31. Those unpaid amounts are being added to the principal instead, causing a process called “negative amortization” where the loan effectively grows instead of shrinking even as borrowers pay.
Because of this change, consumers will take even longer to repay the debt, and CIBC is now expecting many of those mortgages to be amortized over more than 30 years.
Toronto-Dominion Bank and Bank of Montreal also allow variable-rate borrowers to extend the period of time in which they’re expected to pay off the debt. For those lenders, mortgages longer than 30 years accounted for about 30 per cent of each banks’ Canadian mortgage books in the first quarter, up from about zero during the same period a year earlier. The banks attribute much of this growth to floating-rate loans that are now facing negative amortization.
While Royal Bank of Canada doesn’t allow negative amortization, the lender does let variable-rate borrowers stop paying down their principal each month and extend amortization periods to more than 30 years. About $75 billion worth of mortgages, or 20 per cent of RBC’s total domestic residential loan book, are now paying interest only, according to a spokesperson.
“Clients are being helped by brokers to find solutions to keep them in their homes,” said Celia Schneider, a mortgage broker in the Toronto suburb of Oakville.
In the wake of the 2008 U.S. housing crash, negatively amortizing mortgages acquired a bad reputation, with some states subsequently putting limits on the practice as predatory.
The loans in Canada weren’t necessarily pitched as products with negative amortization. Rather, the products are variable-rate loans that include negative amortization as a way for borrowers to avoid higher monthly payments in the event of a very large run-up in interest rates. Toronto-Dominion, Bank of Montreal and CIBC allow variable-rate borrowers to make a lump sum payment to get the debt down or just raise their payments, to avoid going into negative amortization at all.
The government’s proposed guidelines would bar lenders from charging borrowers an early repayment fee if they do that to avoid negative amortization and also prevent lenders charging interest on unpaid interest that has been added to the principal.
CIBC does not let the principal on these loans swell to more than 105 per cent of the original amount, according to a spokesperson. At that point, consumers just have to increase payments or get the principal down.
The banks argue that borrowers should be able to cope with the higher costs, in part because the government stress-tested them to make sure they had the income to handle rates around current levels. Negative amortization, or in RBC’s case, suspension of principal repayment, are just ways to give borrowers time to adjust to the higher rates.
Both CIBC and RBC said the vast majority of borrowers facing this issue will be able to adapt to their higher payments and ultimately pay back their loans, the spokespeople said.
“The banks are doing a favor” to consumers, said Murtaza Haider, a professor of real estate management at Toronto Metropolitan University. “If you were to do a survey of mortgage borrowers, my feeling is that most would opt for this negative amortization over paying $500 more in mortgage costs each month.”
The big question for many of these borrowers will be what happens when their mortgage faces renewal. That’s when the amortization typically reverts to where it started, demanding the higher monthly payments that would go along with a tighter timeline. Because mortgage terms in Canada are typically five years, nearly 20 per cent of mortgages — fixed and variable — are up for renewal this year, according to Capital Economics.
The four banks allowing deals to extend amortization periods said they would work with borrowers to find a new payment plan. Those options could include a permanently extended amortization period or longer periods of interest-only payments. The government’s proposed new rules allow such extensions, even if they’re permanent, but require that lenders keep the length of time reasonable, offer borrowers a competitive rate on the new deal, and make sure their credit scores are not negatively impacted.
With banks encouraged to make sure borrowers can adjust to higher rates, the lenders may be forced to shoulder more of the burden themselves. Capital rules put in place in the wake of the Great Financial Crisis require lenders to bulk up capital as mortgages get riskier.
“A higher assessment of probability of default, or non-payment, would also increase the capital requirements,” Canada’s main banking regulator, the Office of the Superintendent of Financial Institutions, said in response to questions on the subject. “As a result, they may increase their allowances associated with those loans.”
If more banks need to increase capital, that could send ripple effects throughout the system. It would essentially add to the banks’ cost of doing business, at a time when those may be rising anyway given the turmoil at Credit Suisse Group AG in Europe and the collapse of Signature Bank and Silicon Valley Bank in the U.S.
But regulators, and borrowers, may argue that Canada’s banks can afford it. The country’s six largest lenders have a huge share of deposits and loans in their home market and have enjoyed strong profitability to match — shielded by regulators from much competition by foreign firms.
In the five years to 2022, those lenders’ average return on common equity was almost triple that of Europe’s 15 largest banks, according to research from a CIBC portfolio strategist. The price of those profits is that banks are expected by government and regulators to show flexibility to customers when the economic circumstances demand it.
So long as Canada’s banks are willing and able to do that, the floor forming beneath the country’s home prices may hold.
“Individuals who want to hold on to their real estate and ride this sucker out are able to do so,” said Bruce Joseph, managing director of Trident Mortgage Investment Corp., a private lender based in Barrie, Ontario. “By the banks keeping inventory low, it’s creating a little bit of a price stabilization. It’s certainly propping up the market.”
This article was reported by BNN Bloomberg