What exactly are we talking about?
A negative amortization mortgage is a loan where the monthly payments no longer cover the interest and principal. The trigger rate becomes the rate at which the mortgage payment covers interest only. At this rate, no part of the payment is applied to the repayment of capital. When this occurs, unpaid interest is usually added to the mortgage balance, causing negative amortization. The Bank of Canada estimates that approximately 75% of adjustable rate mortgages in the country are repaid in fixed installments. The central bank explains that with such a loan, when interest rates fluctuate, the amount of the mortgage payment does not vary, but the portion of the payment allocated to interest (rather than capital) is modified.
Why do we find ourselves in this situation?
The popularity of adjustable rate mortgages increased during the pandemic when these rates were significantly lower than fixed rates.
Adjustable-rate mortgages accounted for 20% of the country’s total outstanding mortgage debt at the end of 2019. That proportion increased to 33% last fall, according to Bank of Canada data.
The successive increases in interest rates since March last year have hit hard those who took out a variable rate mortgage loan.
Can we talk about a crisis?
The phenomenon is not necessarily synonymous with crisis, at least not to date. The phenomenon of negative amortization occurs in a cycle of rate increases. The share of payments devoted to interest increases and that allocated to capital decreases. The situation reverses when rates start to fall.
Are there many of these types of loans?
Scotiabank’s chief economist, Derek Holt, calculates that about 10% of all residential mortgages in the country are negative amortization loans. To arrive at this conclusion, he said he based himself on the declarations of the five major Canadian banks (Royale, TD, Scotia, BMO and CIBC) and took into account the share of each in the residential mortgage loan market.
Should I fear for my bank?
In a word: no. The major Canadian banks are well capitalized.
The mortgage portfolios of the six largest banks in the country should, according to the credit rating agency Fitch, withstand the pressure exerted by rising rates and the increase in payment defaults on mortgage loans given in particular the low unemployment rates, high levels of immigration and imbalances between supply and demand which support property prices.
Fitch forecasts that mortgage defaults will fall from a record low of 0.14% in 2022 to between 0.2% and 0.25% this year and are likely to remain at these levels in 2024.
However, the authorities act for a reason, right?
With mortgage balances increasing following rising interest rates, the Office of the Superintendent of Financial Institutions adjusted requirements in October so that banks and mortgage insurers hold sufficient capital reserves to absorb the risks posed by mortgage loans which find themselves in negative amortization. The regulator hopes the new requirements will encourage banks to reduce the number of mortgages that would otherwise end up in negative amortization.
What are the solutions for borrowers?
Banks generally work proactively with their borrower customers to try to minimize defaults on residential mortgage loans and thus avoid home foreclosures. Possible adjustments range from improving monthly payments to switching to a fixed-rate loan, including refinancing and even extending amortization periods when the situation allows.
So what impact do the new requirements have on banks?
Minimal and easily absorbable, according to analyst Mike Rizvanovic of the firm Keefe, Bruyette & Woods. “A waiver allows banks to avoid the new capital surcharge if they can demonstrate that their existing models are conservative enough to account for the higher risks associated with negatively amortizing mortgages. »