Canadian Home Price Gains May “Exaggerate” Equity, Manual Approvals Rise: BMO

One of Canada’s largest banks totally thinks your home is worth the appraisal. They’re just going to double-check your income though, uh… for a totally unrelated reason. Home equity levels may be exaggerated, said BMO chief risk officer Patrick Cronin. On the bank’s Q2 2021 earnings call, the executive explained the bank is putting a greater focus on mortgages in fast-rising markets.

In these regions, it’s possible for home price gains to disappear as quickly as they came. To lower risk exposure, they’ve been sending more mortgages for manual reviews. Greater focus is now being placed on a borrower’s ability to continue paying the mortgage… even if they find out their house isn’t worth nearly as much down the road.

Loan-To-Value (LTV) Ratios

Loan-to-value (LTV) ratios are a key risk indicator lenders use. An LTV ratio is the size of the loan, as a percent of the total value of an asset. For example, if you bought a home with a 20 percent down payment, you would owe 80 percent of the value. This would make your LTV ratio 80 percent — the rest is yours. In the event of a sale, they have a claim on the loan amount.

Lenders have less risk with lower LTV ratios, since they can recoup a loss by selling the asset. Borrowers with lower ratios have significant equity in the home. If they get into trouble, they can refinance, etc. More importantly they have skin in the game, so they’ll keep paying.

Borrowers with higher LTV ratios have less equity, and a bigger risk of being wiped out. In Canada, those with an LTV ratio of 80 percent or higher, need to pay for insurance. The odds of a 5 percent down payment being wiped out aren’t far-fetched. If a borrower has no equity, and the payments are just covering debt — the odds of them walking away increases. If the mortgage is insured, the bank is protected for at least part of the loss.

Canada’s Fast Rising Home Prices May “Exaggerate” Home Equity

When asked about risk around inflation and LTV ratios, the bank had some concerns. “With existing homeowners that has the effect of actually improving LTV, so that’s a credit positive. We are looking though very carefully at existing originations,” said Cronin. 

Fast-rising home prices that may be unsustainable are breaking risk protection. Canadian home prices increased by 23% in April, when compared to a year before. This housing “inflation” is reducing LTV ratios very quickly.

An owner of a benchmark home with a 95 percent LTV ratio could see it fall to 72 percent in the past year. The previously insured borrower could now qualify to be uninsured, without a payment. If that equity disappears as quickly as it came, it can be a problem. 

“The elevated home prices may exaggerate LTVs and so, we’re taking our risk management practices on housing [they are] dynamic anyway. And so through the cycle, as prices change, we adjust our practices,” he added. 

The Canadian Bank Is Now Manually Reviewing More Mortgages

The bank is conducting a lot more manual reviews, in regions where home prices are rising rapidly. “…we’re routing more mortgages to manual adjudication, particularly where we’re looking at areas where we’ve seen rapid house price appreciation, just to make sure that we’re comfortable…” said the risk officer, referencing LTV ratios.

“… ultimately, our mortgages and loans are to the borrower’s ability to pay, not the house price and so to the extent we’re satisfied with that, then we’re comfortable from a risk perspective,” he said.  

Your bank isn’t sure about the value of your home, but they’re confident in your ability to pay your mortgage. Maybe the real treasure of the story isn’t the price of homes, but the dividends you made along the way. 

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  • Adam 3 years ago


    • Craig 3 years ago

      haha. What’s that cartoon with the guy finding $20 and says they made this?

    • Quon 3 years ago

      Nice summary tbh. The longer this goes on, the more people pile into leverage. It’s not getting better, it’s getting MUCH worse.

    • Sam 3 years ago

      The funny thing is people will be outraged if a correction comes. Like they gained $200g’s in 2 years….the market corrects let’s say 10-15% …and they’ll be outraged that they lost “thousands of dollars of hard-earned equity”…..

  • GTA Landlord 3 years ago

    Like any good dealer, it’s important to make sure your client can cover their debts. No one wants the supply back.

  • Trader Jim 3 years ago

    I’m always surprised everyone says they couldn’t see prices rising 50% in a year, but they definitely know it can’t fall 50%.

    Those are usually the same people that don’t realize you need a 33% drop to eliminate a 50% climb in asset prices. Not 50%. 😉

    • Mike Perlman 3 years ago

      Man those posts bug me the most, where people can’t even understand basic percentage movements hehe

  • Gerald Haw 3 years ago

    If a home anywhere in the country can rise 50% in a few months, and it was a few months because prices only really took off last October, they can collapse in a few years.

    If the government is wrong, they’re going to have to deal with a lot of problems they didn’t anticipate.

    • expat 3 years ago

      Yeah but governments operate in short term cycles. If the economy looks good, so do we. There’s no tomorrow!

  • Sn 3 years ago

    Yawn… cosmetic changes to mollify the middle class “losers”. They’d sooner fund the hyper leveraged because *wink wink BoC/ Canada is going to step in to bail out the banks. Does anyone doubt that Canada would bail out the banks in case of a serious correction?

    • Sam 3 years ago

      The banks are reporting record profits (again) and comfortable with the risk on lending billions to over-leveraged home-buyers.

      Fact 1….we need a strong banking system. Fact 2…..banks exist for making profits. Fact 3…..Governments and Central Banks regulate and influence the banking system to ensure a strong, balanced, sustainable growth economic environment.

      If it goes to hell…..who’s fault is it?

  • Mathieu Powell 3 years ago

    I have to agree in part with Sn. In this day and age of massive government bailout, big banks have less to worry about.

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