Uninsured mortgages pose increasing risk, Bank of Canada says

The number of uninsured mortgages is on the rise in Canada, and new risks are
emerging alongside these loans, according to the Bank of Canada.

The central bank’s twice-annual Financial System Review shows that mortgage
credit is climbing faster than disposable income in Canada, and Canadians are
leaning more heavily on home equity lines of credit, which is helping to push up
overall levels of consumer indebtedness. At the same time, an increasing share
of the $1.46-trillion in outstanding mortgages across the country are uninsured,
now hovering at 46 per cent.

The federal government’s broad
changes to Canada’s mortgage rules
last fall aimed to cool overheated
housing markets and slow the rise of highly indebted households. Among them,
insurance was restricted to mortgages with an amortization period of 25 years or
less and a purchase price of less than $1-million. Buyers with a down payment of
less than 20 per cent of the home’s purchase price need to have mortgage
insurance to protect lenders from defaults; these are called “high-ratio
mortgages.” Other mortgages are considered “low-ratio.”

The government tightening has indeed brought down the number of borrowers
with heavy debt loads taking out insured mortgages with minimal down payments.
This decline is expected to continue in the coming quarter, the report said.

But as concerns about indebted consumers putting down small deposits recedes,
there are growing risks in low-ratio mortgages, even as these buyers are putting
more than 30 per cent down on average.

This is somewhat expected, since the number of homes worth more than
$1-million is going up in major markets such as Toronto and Vancouver.

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Lenders gain a considerable amount of security and collateral when big
deposits are put down on these pricey homes, even in the hottest housing
markets. As a result the underwriting criteria for these mortgages is a little
more lenient than insured mortgages, with relaxed stress testing and less income
documentation required.

But the risk to lenders here is that this equity buffer could “erode rapidly”
if home prices were to drop dramatically in major markets.

More broadly, the FSR warns of “some riskier characteristics” emerging in
this mortgage segment, including borrowers seeking longer repayment terms and
those looking to avoid onerous insured mortgage requirements.

“I think where we see the signs, in some parts of that market, are really
with respect to an increasing share of those households who have loan-to-income
ratios that are over 450 per cent,” Carolyn Wilkins, senior deputy governor of
the Bank of Canada, said in a press conference, referring to a metric used to
assess borrowers’ ability to make their monthly payments and repay debts. “We’ve
seen that decline in the insured space, but in the uninsured space that’s gone
in the opposite direction.”

The number of uninsured mortgages with amortization dates longer than 25
years is also creeping upward, meaning these homeowners will be slower to repay
their debts, their payments will be lower and the borrowers have less
flexibility to extend their payments if they are faced with an emergency or
other difficulty making payments.

There’s also a worry about where down-payment money is coming from.

“There’s signs that there’s some co-lending going on. If it’s what people
have called ‘the bank of Mom and Dad,’ that’s kind of one thing,” Ms. Wilkins said. “If it’s drawing on lines of
credit or other secondary loans, then of course that does change the financial
profile of the borrower in a way that’s significant.”

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The FSR notes that the Bank of Canada is still waiting on data from 2017 to
assess the riskiness of uninsured mortgages, but the issue doesn’t appear to be

“The overall trends of more issuance and riskier characteristics of uninsured
mortgages are likely continuing in light of the ongoing strength in the hottest
housing markets,” the report states.

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