Just when you thought mortgage rule changes were done for now, here comes another round. While these ones are directed at mortgage insurers (CMHC, Genworth and Canada Guaranty) rather than borrowers, there's a strong chance that consumers will suffer collateral damage from these changes.
The goal of these changes, in a nutshell, is to ensure that federally regulated insurers have enough money set aside in case some waves - or more important a tsunami - hits the Canadian real estate market.
As OSFI (Office of the Superintendent of Financial Institutions, the government agency set up after the sub-prime meltdown of 2008) sees it, it's high time that things were overhauled. The current capital requirements, or monies for a rainy day, were first put into play in the early 1990s and last updated almost 15 years ago. Since that time, not only has the Canadian real estate market changed - dramatically increased in value - but so has the mortgage loan default insurance market and the products that it offers. These products have evolved and changed characteristics while oversight & regulation hasn't.
In addition, OSFI felt that the regulators' understanding of credit risk and how best to model that has greatly improved. Coupling that with the continuing evolution of IFRS (international financial reporting standards), as well as improved economic & financial practices in general, made now the ideal time to both undertake a comprehensive review and more importantly put some new practices into play.
Objectives of the changes by the regulators
Like all great undertakings, you first need to define your objectives. For OSFI the objectives for the new regulations were:
- Create the right risk management incentives for mortgage insurance companies. Translation: come up with a better "carrot (reward) & stick (punishment)" framework.
- Determine requirements for each insured mortgage using direct observable risk proxies and a combination of valuation date and origination date information to ensure a level of conservatism in the protection provided to policyholders and unsecured creditors. Translation: ensure that each specific risk factor is individually considered when providing mortgage insurance, and that not only those factors but the underlying real estate markets are monitored for change; that change affects what's being held on reserve.
- Adapt easily to future changes in accounting or actuarial standards or regulations. Translation: ensure that insurers respond and adapt just as quickly as the world of finance & accounting around them does.
Consequences of the changes for insurers
Now that we've looked at the objectives, let's look at what the consequences of these changes are going to be to the insurers:
- Exposure will be measured on an ongoing basis by using outstanding loan balance on a specific valuation date, thereby ensuring that the pay down rate is accurately captured and only the necessary capital is held against mortgages that are still active.
- The modified loan-to-value ratio will capture with far greater accuracy the borrower's actual equity positon - or lack of - in a property.
- Capital requirements will be differentiated by borrowers' credit scores, ensuring that more capital is held for borrowers who may have a greater tendency to default. These capital requirements will now also take into consideration that credit scores due to age/time (when they were first ascertained) have a propensity to lose their predictive value over time and cannot be relied upon as heavily as an indicator for risk.
- Insurers will now be differentiating requirements based on remaining amortizations on specific valuation dates. This action recognizes the importance of the expected future pay-down rate and considers the progression of the borrower's equity position.
- The base & supplementary capital requirements will not depend on the premium that a mortgage insurer charges for underwriting a particular risk, but instead factor in market changes, amortization, loan-to-value and credit risk.
- By implementing the use of valuation date information rather than origination date information, mortgage insurers will have to maintain up-to-date information on their exposure. In other words, information will be current and not stale-dated.
Effects of the changes on consumers
So what does all of this mean to consumers? Here are some of our team's thoughts on what the changes will likely mean:
- Insurance premiums in the future will not be based largely on the down payment where the more a client puts down, the lower the premium. While the down payment will certainly play a part, the following will also be considered: location (city), overall market valuation changes, credit scores, amortization/time exposure, market where the home is located, per-capita incomes.
- Lower credit scores are going to result in higher premiums. No longer will folks who have lower scores be able to take advantage of pooling to get lower premiums; conversely, folks with great credit score will likely be rewarded.
- Individual real estate markets will impact premiums. Markets that are red hot and overvalued will come with higher insurer premiums for those wishing to buy into them, while stable and fairly flat markets won't result in as much insurer exposure and the need for additional capital will be far less necessary.
- Insurer premiums are likely to become far more dynamic, rather than static like they have been for years, due to the fact that insurers are basically required to do capital risk assessments every quarter.
- Currently all the premiums & products are essentially the same between the three insurers and have been for quite some time. We believe this is likely to change in the future as they carve out some niches and specialize in certain products due to these new capital requirements. They may opt to exit - or enter - into new markets (e.g., self-employed, rental, etc.) due to the risk factors associated with them and the impact of those risks on their capital requirements.
- "One size fits all" will no longer be the norm when it comes to insurer policies & premiums across the land. Going forward, we are going to see geographical diversity; stable and flat real estate regions are far less likely to have to deal with a "one size fits all" policy in order to slow down regions that are red hot and out of control.
From what we can see these changes will be good in the long run, as they will now force federally regulated insurers to remain vigilant of risk assessments, ensure ample capital reserves are on hand, and finally create a dynamic and responsive pricing policy that adapts to changes. That's not to say there won't be some pain along the way, but change has a funny way of doing that.
As far as implementation, a lot of folks may not be aware but OSFI first introduced these new proposed guidelines and changes in September. They then held a period of consultation and input on them which officially ended October 20, 2016, with the intent of full implementation on January 1, 2017. Insurers will have three years (12 quarters) to become fully compliant with the new guidelines. What a way to say "Happy New Year"!
If you're wondering how these and other changes in mortgage regulations could impact you, contact Auxilium Mortgage today to speak with one of our planners: call Toll-Free 1-855-590-6520 or visit us at 307 Goldstream Avenue during regular business hours, Monday through Friday 8:30 a.m. – 5:00 p.m. Our team can also arrange an appointment evenings or weekends to work with you.
Auxilium Mortgage Corporation is based in Victoria, BC and works with clients locally and across Canada. The Auxilium team has over 100 years of combined financial experience and access to dozens of lenders to help you meet your goals.