Canada’s problems with a little-known risky mortgage product are more significant than expected. OSFI, the country’s bank regulator, has targeted combined loan plans (CLPs) for the past few years. CLPs enable interest-only payments, allowing borrowers to carry mortgage debt perpetually. The regulator called these a “systemic risk” that inflates home prices, so it’s clearly a serious issue. However, analysts largely ignored it since the extent of the issue was unknown. It turns out these loans are a massive share of mortgage debt, representing most newly accumulated housing debt.
Combined Loan Plans aka Readvanceable Mortgages
Combined loan plans (CLPs), or “readvanceable mortgages,” combine a mortgage and HELOC. Principal repayment is magically turned into available credit to withdraw. No need to conduct an equity takeout; the credit is automatically available. The more paid down, the more available to borrow. It’s a useful product if used prudently, but it’s easy to spot how this can quickly become a big problem.
The issue isn’t just theoretical—OSFI stated multiple times that CLPs are a “systemic risk.” They warned the product is helping to hide payment stress, and driving home prices higher. They finally cracked down with new regulatory guidelines last year.
Updates to the mortgage guideline sought to limit CLP leverage. The maximum loan-to-value (LTV) ratio for mortgage and readvanceable credit is limited to 65% in total. In other words, the first 35% of equity can’t be used for a readvanceable loan. Additional equity can still be borrowed, but the portion needs to have an amortization that gives a firm repayment date. This helps to reduce vulnerability to sudden economic shock, such as unemployment or rising bills.
Despite the regulations, the prevalence of the problem remained a mystery. Now that we have some data, they were getting ahead of an astronomically sized problem that still remains.
CLP Debt Has Surged 50%, Rising At Nearly 2x The Rate of Mortgages
Think Canada’s addiction to mortgage debt was problematic? Their addiction to perpetual mortgage debt is even worse. Outstanding CLP credit hit $805 billion in Q3 2023, rising nearly 50% since 2019. Total real estate secured lending (RESL), an aggregate of mortgage and HELOC credit, rose 30% over the same period. That means nearly 2 in 3 dollars of accumulated housing debt was in the form of a CLP mortgage.
Canadian Combined Loan Plan Mortgage Debt
The outstanding balance of Canadian combined loan plan (CLP) mortgage credit.
Source: BoC; Better Dwelling.
Note: 2019 is the first year the BoC has made data available.
Rapid growth in CLP credit has been consuming residential RESL debt. It now represents 42.5% of household RESL as of Q3 2023, rising 5.6 points since 2019. Regulators already considered this debt risky, and a contributor to higher home prices. The picture is much worse considering the share with little equity or close to maxing out their credit.
Canadian Mortgage Borrowers Increasingly Turned To CLP Mortgages Despite “Systemic Risk”
The outstanding balance of combined loan plan mortgage credit as a share of total residential real estate secured lending (outstanding mortgage and home equity).
Source: BoC; Better Dwelling.
Nearly 1 In 3 Dollars of CLP Debt Are To Borrowers With Little Equity
If OSFI considers CLP borrowers with less than 35% equity to be risky, there’s a lot of risky mortgages. Outstanding credit to CLP borrowers with LTVs of 65% or higher reached $269 billion in Q3 2023, up 36% from last year. Roughly 1 in 3 dollars lent to CLP borrowers had limited equity and should be shifted to an amortizing loan.
A high utilization rate is often considered a red flag for lenders. These are borrowers that have borrowed 80% or more of the credit extended. Since these borrowers have little to no room in the event of an emergency, default risk rises fast. The outstanding CLP debt to these borrowers hit $78.7 billion in Q3 2023, nearly 10% of total CLP debt. On the upside, this is down 4% from last year, and the amount peaked in Q1 2023. Still a lot of risky debt, but things are improving… slowly, but improving.
The data helps provide more context into the cheap and easy credit that helped investors dominate the market. It’s well-established that home equity borrowing helped to fuel the recent speculative frenzy. The scale of the home equity borrowing issue was obfuscated by HELOC-only data. Home equity borrowed via readvanceable mortgages was largely hidden in aggregate mortgage credit.
OSFI’s primary concerns are risk associated with perpetual balances, and the impact on driving home prices higher. The problem may be much worse if these funds found their way into real estate speculation. In that case, they didn’t just fuel higher prices—they also compound financial system risk. People often forget that leverage works both ways, amplifying both gains and losses.
The regulator’s aggressive crackdown has helped to tame some of the risk. However, the scale of this risk is much bigger than anyone anticipated. It’s hard to see how a problem this large is de-risked by just asking people to buckle down and pay off debt. Especially without dumping further liabilities onto the general public.