Ottawa proposes sweeping changes to spread mortgage risks
Tamsin McMahon - REAL ESTATE REPORTER
The Globe and Mail
Published Friday, Oct. 21, 2016 10:14AM EDT
Last updated Friday, Oct. 21, 2016 11:34AM EDT
Ottawa is launching consultations with the financial industry that could see lenders shouldering as much as 15 per cent of the costs of losses on defaulted mortgages that have government-backed insurance.
The Department of Finance
released a 22-page consultation paper laying out its vision of sweeping changes to Canada’s 62-year-old mortgage insurance system in an effort to shift more of the risks of Canada’s hot housing market from taxpayers to lenders themselves. It is asking for lender feedback by Feb. 28.
“Lender risk sharing represents a potential approach to rebalance the distribution of risk in Canada’s housing finance system, to take advantage of lenders’ abilities to manage housing risks, thereby reducing taxpayer exposure, while continuing to meet housing finance objectives of financial stability, access, competition and efficiency,” the government wrote in its paper.
Canada’s mortgage insurance system guarantees that taxpayers will shoulder virtually all of the costs of mortgages that default, paying lenders for lost principal and interest, as well as for the costs of foreclosing on a property, such as legal fees and property maintenance.
Financial institution themselves are on the hook for little, if any of the costs of dealing with defaulted mortgages. Taxpayers shoulder 100 per cent of the costs of mortgages insured by Canada Mortgage and Housing Corp. and 90 per cent of the costs of CMHC’s private-sector competitors.
More than half, 56 per cent, of roughly $1.4-trillion outstanding mortgage debt in Canada is insured, although that share has been declining in recent years due to a several rounds of rule-tightening by Ottawa since the 2008 financial crisis.
The federal government’s paper lays out two scenarios that could see lenders shouldering as much as 15 per cent of the losses associated with a defaulted mortgage that is backed by taxpayer-guaranteed insurance.
One option, would require lenders to absorb a fixed percentage of the total outstanding value of a defaulted mortgage, in the range of 5 to 10 per cent, according to Ottawa’s proposal.
Another option would require lenders to absorb a percentage of the total loss associated with a default mortgage, pegged at 15 per cent.
The difference between the two could be substantial.
Ottawa estimates that under the first option lenders would be on the hook for a maximum of $15,000 of costs associated with a $300,000 mortgage that defaults, regardless of how much money lenders or insurers are able to recover. Under the second scenario, lenders’ share of the costs would change depending on the size of the loss, with lenders on the hook for as little as $9,000 if lenders can recover 80 per cent of the total value of the mortgage, or as much as $22,5000 if they can recover only half.
The government is proposing to implement the deductible in the form of a separate fee for lenders. Mortgage insurers would continue to pay out 100 per cent of mortgage default claims, but then charge lenders a fee based on the total value of mortgages on their books that default in a given quarter.
The structure would protect CMHC’s $440-billion mortgage-backed securities program, which also has a taxpayer guarantee, Ottawa said Risk-sharing will ultimately require mortgage lenders to hold more capital against riskier loans while insurers, including CMHC, would hold less.
Ottawa estimates the measures would add 20 to 30 basis points to lenders’ mortgage costs, although mortgage insurance premiums would likely fall, meaning consumers who take out insured mortgages would not see a dramatic rise in mortgage rates.
However, the government said the proposal could lead to mortgage insurance premiums that are more in line with the risks of an individual mortgage, such as a home buyers’ credit score or the strength of the local housing market. Currently, mortgage insurance premiums are based only on the level of a borrower’s down payment.
Ottawa said it expected that any risk-sharing plan would apply only to new mortgages and would be rolled out gradually. The government expects the proportion of insured mortgages subject to risk-sharing to rise quickly in the first five years, but require up to 10-20 years to fully take effect.
