Fixed-payment variable rate mortgages a “dangerous product,” says OSFI
Canada’s banking regulator said Thursday it views fixed-payment variable-rate mortgages as a “dangerous product” that puts certain borrowers at increased risk of default.
Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), made the comments during testimony before the Standing Senate Committee on Banking, Commerce and the Economy.
“The variable rate product with fixed payments is a dangerous product in our view because itputs the homeowner in the position of an extended extended period—not always, but in this environment certainly—it can put the homeowner in the position of paying a flat rate of, say, $2,000 a month, and the interest on their mortgage is $3,000 a month,” Routledge said.
“And that means their mortgage balance is growing, and that increases their vulnerability, and increases the risk of default,” he continued.
While he said OSFI’s role is not to “impose a judgment on product design,” Routledge did say OSFI would “like less of that product. We think the system would be healthier with less of that product.”
What are fixed-payment variable rate mortgages? These mortgage products, which are offered by most big banks except for Scotiabank and National Bank, keep monthly payments fixed even as interest rates fluctuate. When rates rise, less of the borrower’s monthly payment goes towards principal repayment and a greater portion ends up going towards interest costs.
OSFI estimates that $369 billion worth of outstanding mortgages—out of a total mortgage market of $2.1 trillion—currently have fixed-payment variable-rate products. Of those, approximately $260 billion worth have seen their amortization periods soar to 35 years or longer.
This isn’t the first time OSFI has voiced its concerns about this specific mortgage product.
The banking regulator, which oversees lenders that underwrite 80% of all mortgages in Canada, previously said it would be better if these mortgages are less prevalent in the market.
Meanwhile, experts have pointed out that these products have so far cushioned many variable-rate mortgage borrowers from the full impacts of the Bank of Canada’s rate hikes. In most cases, it means they will instead face a payment shock at renewal, similar to those with fixed-rate mortgages—and potentially more so if their mortgage had been negatively amortizing.
Comments on OSFI’s proposed debt-serviceability measures
Routledge also commented on the results of OSFI’s public consultation feedback on proposed mortgage underwriting changes it had introduced earlier in the year. In that report, OSFI confirmed that it would no longer pursue two of its proposals: debt-to-income (DTI) restrictions (while keeping LTI restrictions on the table) and debt service loan coverage restrictions.
Routledge testified that the “overwhelming response” from its stakeholders was that the current mortgage stress test is sufficient.
“We may not entirely agree with that, but that was what we heard from our regular constituents,” he said.
Routledge acknowledged that given the “relative stability” of the housing market so far and the “very low” credit losses overall, that “we decided that we weren’t going to rush to change the mortgage stress test. And by that, I mean either A) changing the way we calibrate it, which is [currently] to add 200 basis points, or two percentage points, to your contract rate, or to consider at a systemic level new debt serviceability offsets.”
However, Routledge also said that doesn’t mean OSFI won’t continue looking at implementing more targeted protections.
“We regulate bank by bank and we have the supervisory flexibility to look at complements to mortgage debt service ratios that might add a little bit more protections into the system.”
This article has been updated to provide further clarity to some of Routledge’s comments.