Canada’s banking regulator is proposing to make it more costly for lenders to accommodate mortgage borrowers who stretch out their loans in an effort to limit housing-market risks in the financial system.

Lenders would have to hold more capital against mortgages that are in “negative amortization” — that is, in which the monthly payments are no longer enough to cover the interest owed, and so the balance is getting bigger. The new rules would apply to mortgages where the loan amount is 65% or more of the value of the property, according to a proposal released Tuesday by the Office of the Superintendent of Financial Institutions.

The move is the latest attempt by regulators to contain fallout from the Bank of Canada’s interest rate hikes over the last year.

Canada’s pool of variable rate mortgages, which track the central bank’s overnight rate, have come in for particular scrutiny. The products became very popular when rates were at record lows during the early part of the Covid pandemic. But when the central bank raised rates sharply last year, some borrowers took the option of not paying the full amount of interest they owe each month.

This unpaid interest is tacked onto the principal instead, a process called negative amortization because as the loan grows, the lender extends the total time for it to be repaid.

The regulator’s proposal for higher capital requirements would provide one more curb on how the banks use this tool, and “encourage banks to lessen the number of mortgages that would otherwise go into negative amortization,” OSFI said in its proposal. It will be open for comment until Sept. 1.

The change to the bank’s capital requirements wouldn’t cause borrowers’ monthly payments to increase during their current term, the statement said.

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