A recent story over on Mortgage Broker News is creating a bit of a stir.
It seems TD Bank has quietly changed the fine print on its Variable Rate Mortgage contracts for conventional mortgages – specifically around when a spike in loan to value triggers demand for a lump-sum payment or a new appraisal.
Under the terms of the new clause, if, at any time and for any reason, the loan-to-value on a conventional mortgage exceeds 80 per cent, the bank has the right to direct the borrower to bring it under that 80 per cent threshold or to obtain an appraisal proving the fair market value is indeed higher. The new wording replaces a similar clause that sets that trigger at 75 per cent but limits the scenario to instances where interest rate fluctuations have driven LTV over that 75 per cent mark.
Patrick Mulhern of Invis Mulhern Mortgages, who tried to get an explanation from TD without success, suspects that change is really a hedge against any future price correction for Canadian real estate.
Under the terms of the new clause, if, at any time and for any reason, the loan-to-value on a conventional mortgage exceeds 80 per cent, the bank has the right to direct the borrower to bring it under that 80 per cent threshold or to obtain an appraisal proving the fair market value is indeed higher. The new wording replaces a similar clause that sets that trigger at 75 per cent but limits the scenario to instances where interest rate fluctuations have driven LTV over that 75 per cent mark.Mulhern believes that new, wider clause speaks to the lender’s concerns about a possible market correction and its power to drive down property values.“In the new clause, it states that if at any time the principal balance exceeds the max LTV.” he said. “This protects the lender in case of property devaluation."
The amendment took place sometime last year, according to Mulhern, and he was only made aware of it because of an increase in variable rate mortgages he recently arranged.
“Unless I’m reading it incorrectly this type of clause has nothing to do with rate fluctuations and everything to do with loan-to-value,” Mulhern said. “Property value decreases would have a huge impact on all TD variable rate mortgages.”
Garth Turner, who covered the story in a blog post today, noted the impact this change could have:
If, at any time or for any reason, the value of your house drops to a level less than 80% of the amount of mortgage debt, then the bank can demand you write a cheque to cover the difference. If you don’t, your mortgage goes into default. You also have the right to have your property appraised (at your cost) to prove it’s worth at least 80% of the loaned amount, whenever the bank demands such proof.The old limit was 75%, and the former wording also limited the nightmare scenario to situations in which rising interest rates triggered the action. This time anything – like unemployment triggering a highly local market decline – means you have a problem.
One realtor Turner spoke to had this observation:
“I think it’s preparation in the event of a price melt down and they want a 20 % cushion instead 25% to minimize the bank’s exposure to non CMHC mortgages.”
Garth Turner agreed and said:
"Exactly. The bank is preparing its non-insured portfolio against what might be inevitable, if the Bank of Canada is correct.It’s only prudent, if you’re the lender.
It’s a potential hell on wheels, if you’re the borrower."
The clauses are compared side by side. First the old (click image to enlarge):
and the new:
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If, at any time or for any reason, the value of your house drops to a level less than 80% of the amount of mortgage debt, then the bank can demand you write a cheque to cover the difference. If you don’t, your mortgage goes into default. You also have the right to have your property appraised (at your cost) to prove it’s worth at least 80% of the loaned amount, whenever the bank demands such proof.
ReplyDeleteGarth thinks we have 125% mortgages in Canada?! I thought it was the opposite, the loan must remain under 80% of the house value.
The good news: your house might still be worth a million bucks. The bad news: a million bucks will soon be worth 750 grand. So I hoped you enjoyed that little taste of world travel....we won't be having any of that anymore.
ReplyDeleteThanks Jim Flaherty! You're swell!
No way these changes would be introduced unless there had been some serious discussions in the boardroom beforehand. The consensus amongst them is to take action proactively ahead of trouble that must be on the radar now. We don't therefore need the bank to come out with bearish messages on the economy or housing for confirmation all is not well. We only need watch what they do, not what they say. This change speaks volumes as do those in the past modifying terms of LOC's which most homeowners carry and it increases the leverage of the lender over borrowers. What is interesting about this is that the banks might be calling in cash well ahead of any actual crisis and thus protecting their own bottom line while mitigating risks. They won't be facing the prospect of having large numbers of foreclosures to deal with in a short period of time. It is an ingenious solution actually but bears watching closely. If we start seeing a lot of call loans action or demands from borrowers to ante up differentials between loan values and appraisals we will know trouble is brewing. That message won't make it to the media though except perhaps via quarterly bank reporting. In other words, the first signs of trouble in the uninsured mortage market will not be publicly visible and this will allow banks to keep up the pretense that consumers are not really all that overleveraged and that the mortgage business is hunky dory. So this action unlike actual forclosures will be less transparent for the public and media if it evolves. The other interesting aspect is that this will allow the bank to maintain its ratios and thus should reduce the numbers of foreclosures. They have set a bar at 80%. If housing prices declined 30% over the course of several years this would set up the circumstances to create pressure on borrowers to keep the ratio intact in a rather gradual manner and thus head off debt extinction through bankruptcy. Assuming that most people can come up with a way to bridge anywhere from 3 to 7% differential in debt versus home value in any given year it begs to reason they will find a way to cover even if equity falls for several years in a row. Lots of pressure no doubt and it will certainly put a hole in both disposable income and savings during those years but in general I like their idea. It is kind of just another way of accelerating payments and most people will handle it. Overall this strikes me as a good idea that benefits both banks and consumers.
ReplyDeleteThis is for all unisured (CMHC) mortgages. Because of the run up in prices over the last 10 years it wont affect the majority of home owners. Boomers in Vancouver and Toronto (unless they sold and bough more expensive homes) likely have way more than 20% equity in their homes and can even withstand 20-30% drops in value without any affect. It will be the newbies that will be hurt the most, those that just saved up enough for a 20% down payment and then the market corrects. Ouch
ReplyDeleteDaughter works for TD and noticed it late last November when helping one of her investment bankers complete a re-ap for a client. Called a Trigger clause and they are using them....
ReplyDeleteOthers to follow one would think.
The phrase action's speak louder than words comes to mind. Read the old and new, and note a key difference- in the old version the borrower had the option to convert to a fixed rate loan as a potential remedy. That is now gone.
ReplyDeleteThe question as to why a bank would remove the option to keep an otherwise paying homeowner from going to a fixed rate is an interesting one. It seems that a rationale could be that the risk of doing that is too much versus immediate demand and foreclosure if necessary. Two potential arguments come to mind 1) interest rate environment rises and already over-stretched consumer can't tolerate the higher future payments and/or 2) property values falling so fast that fixed rate paydown won't make up for the reduced equity.
These are hypotheticals, but the change does beg the question as to why push so hard on a theoretically currently paying customer.
CanAmerican
To me this is akin to the bank creating an early warning system of its mortgage portfolio during a period of asset deflation. I don't think many of us here feel that prices can rise much further before a reconciliation eventually happens. In this case, as equity declines, pressure will be applied well before defaults occur and well before jobs losses associated with a financial crisis appear. In the US we did not see anything this creative after their housing bubble burst. What we saw instead was blunt reactions after the fact as people who had drifted deep into negative equity as high as 50% (in worst cases) over a multi year period simply gave up. Their prospects were so dim that their only options were defiance or walking away. The outcome was mass defaults, foreclosures, home seizures, evictions and finally exhaustion for all parties. But look at this new idea with fresh eyes. Keeping to a ratio means that some people will be forced into default earlier than usual while most others will scramble to make up the difference in a gradual way to keep the ratio intact. What that does is spread risk over a longer period of time on the one hand while reducing the risk that the consumer ends up in a hopeless position after an asset bust. So the banks stay whole and don't have to deal with too many simultaneous foreclosures under crisis while the homebuyer meanwhile will become more rather than less invested in his own investment during a difficult period in the economy. It is a brilliant change actually. This ratio idea should mitigate risk all round. The last damn thing the country needs is a housing crisis because that is so incredibly destabilizing of all other parts of the economy. Lets hope all the banks get on board with similarly designed changes that stand to soften any blows that might come down the road.
Delete