Ottawa floats changes to mortgage default risk system

The federal government said Friday it wants to hear from players in the financial industry on lender risk sharing, a move that could see financial institutions absorb a portion of loan losses on insured mortgages that default.
The federal government is proposing changes that would shift some of the default risks on insured mortgages to lenders. (Jenna Reid)

The federal government said Friday it wants to hear from players in the financial industry on the topic of lender risk sharing, a move that could see mortgage lenders absorb a portion of the losses if insured mortgages that default.

In a document posted online by the Department of Finance, the government said it wants feedback on two proposals on lenders risk exposure.

The first one would see lenders forced to cover a fixed portion of an outstanding loan balance if it goes into default. The second scenario would see a lender absorb a percentage of the total loss on a mortgage default after factoring in default costs and money recovered from the sale of a foreclosed property.

Under the current system of the mortgage insurance, lenders shift virtually all the risk of an insured mortgages to mortgage insurers, and indirectly to taxpayers through federal-government backing.

However, the governments pointed out that the International Monetary Fund, the Organisation for Economic Co-operation and Development, and others have said limiting the exposure of mortgage lenders to defaults could put too much risk on the public sector.

"Rebalancing some of this risk towards the private sector could further incentivize and strengthen risk management practices, and as a result further mitigate taxpayer exposure," the Finance Department said in its consultation paper.

In Canada, federally regulated lenders are required by law to get mortgage default insurance for homebuyers who make a down payment of less than 20 per cent of the property purchase price. Mortgage insurance is also available to other mortgage lenders, and for mortgages with down payments of at least 20 per cent of the property purchase price, to support access to low-cost mortgage funding and promote greater competition amongst lenders.

Under current rules, the federal government covers 100 per cent of Canada Mortgage and Housing Corp.'s obligations to lenders for insured loan losses. Additionally, Ottawa covers up 90 per cent of the obligations to lenders of the private mortgage insurance providers, Genworth Financial Mortgage Insurance Company Canada and Canada Guaranty Mortgage Insurance Company.

The government says that as the Canadian residential mortgage market has grown, so too has the portion that is insured with government-backing. Insured mortgages represent an estimated 56 per cent of the total outstanding residential mortgage credit, and mortgage insurance is used by all types of lenders to insure about 40 per cent of new mortgages.

Possible changes to mortgage pricing

Ottawa says that under risk sharing, lenders' exposure to loan losses would rise, increasing their expected losses and pushing up their requirements to hold more capital. Conversely, mortgage insurers could see lower losses, resulting in  result in lower total capital requirements for them. 

"This would alter the costs that lenders and mortgage insurers would expect to face in originating an insured mortgage, with potential impacts on both mortgage supply and pricing and mortgage insurance premium pricing," the government's consultation document says.

The government says it wants to hear from all parties with an interest in the housing sector by the end of February 2017.

Earlier this week, new federal mortgage rules kicked in. They are an attempt to rein in consumer debt loads, and are likely to cool house prices too. By making it harder to get a mortgage, demand for housing becomes limited, which should cause prices to drop or at least not increase as quickly.


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