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Banks seek workarounds to avoid mortgage default for struggling variable-rate borrowers

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Banks of Canada are trying to ease the burden on homeowners who can’t keep up with rapidly rising interest rates by extending mortgage write-offs and possibly adding outstanding amounts to the loan principal. period, but it can have long-term consequences.

After raising the overnight rate to 3.75% from near zero at the beginning of the year, bank of canada this week, nearly 50% of borrowers with variable-rate fixed-repayment mortgages trigger rate — The point at which the set monthly payments cover interest only and principal remains unpaid. Nearly 13% of all mortgages in Canada are affected, according to the central bank.

Federal regulations stipulate that mortgages must be written off. In other words, the borrower has to repay the principal. Subject to negative or reverse write-offs for a period of time under rules set by banking authorities and mortgage insurance companies.

Negative amortization or reverse amortization occurs when mortgage payments are not sufficient to cover unpaid interest, and the excess amount is added to the principal of the loan.

Dan Eisner, CEO of True North Mortgage in Calgary, said extending the repayment period is one way to solve the trigger rate problem, saying, “Each bank does this a little differently. We have chosen to process it with

“If a borrower raises their hand and claims they are facing financial difficulties, as a lender, they can extend amortization to reduce the amount they pay back.”

Another industry watcher said it was “reasonable” to conclude that reverse amortization is also taking place, although there is no public data yet. This could increase risk for lenders and borrowers, as loan balances are actually increasing and could be a particularly worrying development when property values ​​are falling.

The Toronto-Dominion Bank says on its website that higher interest rates could put customers in a position to “start accruing accrued interest” on their mortgages. , the borrower will eventually have to adjust the payment, make an advance payment, or change to a fixed-rate mortgage.

If a borrower fails to keep up with mortgage principal and interest payments, the likelihood of default increases, but industry watchers look to mortgage insurers such as Canada Mortgage and Housing Corporation (CMHC) and Sagen (formerly Genworth Canada) The company says it allows banks to make quick payments. Work out with individual clients as needed without individual client approval.

For example, CMHC allows negative amortization up to 105% of the original loan amount. For uninsured mortgages, federally regulated lenders have their own policies approved by the Financial Institutions Regulatory Authority.

“For uninsured mortgages, OSFI does not set specific write-off limits that allow financial institutions to write off negatively,” said Carol Signdon, a spokesperson for the federal banking regulator. We expect it to stay within banks’ risk appetite.”

In an emailed statement, Saindon said OSFI is “continuing to work with federally regulated financial institutions to assess the impact of any actions they are considering.” Stated.

Eisner said the bailouts are only a concern if they become a blanket policy.

“If a major bank announces some kind of auto-amortization extension, it would be expected that all lenders would offer an auto-extension,” he said, noting that such a scenario would be a risk to lenders who need to build capital. Or added that it is not good for borrowers. House.

CMHC said in a statement that approved lenders have the “flexibility to make special arrangements” at their discretion with their customers without the approval of the mortgage insurer, although it does not allow borrowers to ” Only if you have a documented analysis on file of your own financial situation.

“They really have to prove financial hardship,” Eisner said.

It won’t be painless for the economy, nor is it designed to be

Avery Shenfeld, Chief Economist, CIBC Capital Markets

Mortgage analyst and strategist Robert McLister said the extent to which triggers for larger payments matter would depend on the actions of the Bank of Canada.

If overnight rates were only to rise by another 50 to 75 basis points, as the bond market suggests, “we would come out of the woods relatively unscathed,” he said. “This will be especially true if interest rates turn lower by the end of next year,” he said.

But if the central bank sets interest rates above 5%, “it could lead to unforeseen arrears problems,” he said. I wouldn’t be shocked if they announced the measures.”

One way to do this is to formally allow amortization extensions of up to 40 years for highly leveraged borrowers. Mortgage default insurers are backing this up, McClister said.

About 16.6% of Canada’s 6 million households with mortgages could reach the trigger rate, according to McLister’s calculations.

“In other words, almost 1 million households could hit the trigger rate if interest rates get high enough,” he said. However, only a subset of them, perhaps less than one-fourth of him, will experience reverse his amortization, where accrued interest will be added to the principal. The rest will be increased monthly payments by the lender to ensure that any unpaid interest is covered.

“So we’re really talking about the hundreds of thousands of households whose mortgage balances could increase before maturity,” McLister said.

A further subset of these, perhaps one in five, could be vulnerable to a significant interest rate rise at maturity, based on Bank of Canada data, and “using the past as a guide, one of those Only digit percentages can default.”

Avery Shenfeld, chief economist at CIBC Capital Markets, said Canadians have a lot of stock in their homes and could sell and shrink if they can’t, so the relief offered by banks said he didn’t think it would cause a major shock to the financial system. As long as the Bank of Canada doesn’t “overdo” policy tightening, they can buy their current property longer.

“Large regulated financial institutions have been stress testing for years to see if borrowers can pay higher interest rates when they underwrite their first mortgage,” Shenfeld said. says Mr.

“But it won’t be painless for the economy, nor is it designed to be. After all, the Bank of Canada is raising interest rates with the intention of slowing the economy and thereby cooling inflation, One of the main channels of that slowdown is to squeeze people who are heavily indebted (including mortgage borrowers hitting trigger rates) or thinking about buying a home. I’m here.

Differences in mortgage products offered by Canada’s largest banks can impact your experience of loan delinquencies and defaults.

CIBC Capital Markets analyst Paul Holden said Bank of Nova Scotia and National Bank should be careful because they offer “variable payment” products that pass higher interest rates directly to customers. said.

“(This) means that higher borrowing costs will flow faster to floating-rate customers. We will therefore be monitoring the outcome closely going forward for signs of payment stress,” the analyst said. .

But even with tools in place to manage the impact of rising interest rates on fixed-payment variable-rate mortgages, the full impact won’t be felt until those mortgages are renewed.

“This gives banks and their customers time to prepare for higher future payments, assuming interest rates remain high,” Holden said. “This is something he should monitor until 2025/2026 when the lowest interest rate (5 year) mortgage is renewed.”

A Bank of Nova Scotia spokesperson said the company’s mortgages are designed to help borrowers “stay on track with their scheduled principal repayments for the life of the mortgage.” .

As prime rates rise and payments change, lenders will send letters to their clients, Andrew Garath said, adding that there is never a point in time when borrowers pay only interest, so interest can be reduced over time. rice field.

“We work with each customer individually to understand their unique needs,” says Garas.

National Bank spokeswoman Alexandre Guay said lenders are “proactively” reaching out to clients “who may be more vulnerable to confirming their situation,” and are communicating with all affected clients and He said he was making every effort to make them aware of the changes and offer advice.

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