While cheap housing debt from non-bank mortgage lenders has made home-buying easier, the less-regulated firms may also make the financial system more vulnerable if a real estate correction occurs.
So concluded a report accompanying the central bank’s December Financial System Review. Policy makers estimate that by the end of last year, the four biggest mortgage finance companies alone had $165 billion in outstanding mortgage loans, accounting for some 12% of the total market, according to the Globe and Mail
Mortgage finance companies get almost all of their funding from writing insured mortgages and selling them to major banks or institutional investors through the mortgage-backed securities programs of Canada Mortgage and Housing Corp.
By allowing such lenders to hold very little capital, the “originate-to-sell” business model has allowed them to keep costs low, which has driven down mortgage rates and increased the availability of credit. “But these benefits have been accompanied by an increase in financial system vulnerabilities,” said the central bank’s researchers, who found that non-bank lenders’ clients tend to take out larger loans and spend more of their income servicing debt payments.
The trend is explained by the concentration of non-bank lender activity in Toronto and Vancouver, Canada’s most expensive housing markets. The two regions accounted for 22% of non-bank mortgages that have down payments of less than 20%, compared to 12% for banks and credit unions.
Almost 30% of non-banks’ insured mortgages exceeded 450% of borrowers’ incomes or were extended to those who spent more than 42% of their income on debt payments, whereas only 18% of lenders have such exposure. They could therefore encounter problems during a downturn, as the risk of homeowners defaulting on their mortgages is increased.
Banks might also scale back their purchases of mortgages during a housing crisis, which would make it harder for mortgage lenders to offer new loans and consequently force some customers to scramble for financing as their mortgages come up for renewal. “These borrowers could be forced to renew at higher interest rates or sell their house at a discount, which could have a negative feedback effect on already weakened housing markets,” researchers said.
The industry is also more vulnerable to changes in federal regulation of mortgages: the central bank estimates that 43% of non-bank insured mortgages to borrowers with down payments below 20% would not be allowed under stricter new rules, and 59% of loans with higher down payments would no longer qualify for government-backed portfolio insurance.
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