OSFI takes a small step to reduce equity borrowing

A new home is offered for sale in a new housing project in Ottawa on July 14, 2020.Sean Kilpatrick/The Canadian Press

The Canadian bank regulator plans to better protect the country’s financial system by limiting how much homeowners can borrow against the value of their homes.

The main objective of the Financial Institutions Supervisor’s Office is the popular Rehabilitable Mortgage, or Combined Loan Plan (CLP), in which a conventional mortgage is combined with a line of credit that grows in size when a customer pays off the principal of the mortgage.

For months, the regulator has called on highly-leveraged CLP borrowers to create vulnerabilities in the financial system. The regulator considers borrowers to be risky if they owe their lender more than 65 percent of the home’s value, also known as the loan-to-value (LTV) ratio.

The ratio is a key metric used to assess risk in a financial system, and the lifetime value of a loan above the limit represents a level of indebtedness that can cause problems for lenders.

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OSFI said the main concern about CLPs is when a borrower’s home equity line of credit, or HELOC, continues to grow when the borrower’s minimum credit is above 65 percent.

“Products structured in this way can lead to the perpetuation of outstanding balances and increased risks to lenders and households,” OSFI said in a press release announcing the changes.

Under current rules, once borrowers make a mortgage principal, they can immediately get the same amount back from the HELOC, and the HELOC can increase to 65 percent of the home’s value. The entire loan amount cannot exceed 80 percent.

OSFI’s new rule will only allow repossessible mortgages to be borrowed if the entire mortgage ratio is less than 65 percent. This means that when borrowers pay off the principal of the mortgage, they may not be able to re-borrow that amount immediately.

The mortgage industry said the changes will have little impact on the financial system, given that most lenders are already limiting borrowers once they reach the 65 percent threshold.

“Today’s consultation appears to be an announcement of the way things are generally done in those OSFI-regulated financial institutions – a public announcement of current best practices,” said JP Boutros, director of government relations at mortgage lobby group Mortgage Professionals Canada.

Any benefits to the financial system would be “virtually imperceptible,” said Rob McCallister, a mortgage strategist.

“The maximum loan-to-value on the revolving portion has long been 65 per cent and that is not changing,” he said. “If someone wanted to blow their minds, raise their HELOC to 65 percent of its permanent value, and only make interest payments until infinity, they could still do it.”

The new rules will take effect after the lenders’ next fiscal year, in either October or December of 2023, and will only apply when the borrower renews their mortgage. If home prices fall significantly, this can lead to a deterioration in the value of the property of the borrower and the permanent value ratio of the borrower.

As of the end of the first quarter of this year, syndicated loan products were worth $737 billion, according to Bank of Canada data. This constituted 42 percent of total secured housing lending. Highly indebted CLP borrowers made up 11.5 percent of total secured home lending.

OSFI also said it will strengthen lending requirements for mortgages with features of joint equity and reverse mortgages.

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