Why is FSRA interested?
Recent economic and market uncertainty, significant home price appreciation and more stringent underwriting criteria introduced by OSFI for federally regulated lenders have made it more difficult for consumers to obtain or maintain mortgages with traditional lenders.1 As a result, more consumers are turning to alternative and private mortgage financing options, with the help of mortgage brokerages, brokers and agents. Some of these consumers may be more financially vulnerable, and FSRA is concerned that they could be taken advantage of in private mortgage transactions.
From 2020 to 2021, FSRA’s mortgage conduct supervision team sought to better understand the “real-world” nature of private lending transactions as outlined in the mortgage brokering sector supervision plan for that period. FSRA also assessed the role of the mortgage broker/agent as intermediary. In addition to soliciting feedback both anecdotally and through its Mortgage Brokering Technical Advisory Committee, FSRA also conducted examinations of brokerages engaged in private lending and arranging private mortgages.
What we did
The primary goal of the private mortgage examinations was to evaluate compliance with the Mortgage Brokerages, Lenders and Administrators Act, 2006 (MBLAA) and its regulations. In particular, we sought to understand areas that pose a higher risk of brokerage non-compliance and/or consumer harm that require more careful attention by licensees.
With that in mind, FSRA selected a diverse set of brokerages engaged in private mortgage transactions, to ensure that the practices reviewed were a representative sample of the industry. We focused on the brokerages and their brokers’ / agents’ know-your-client processes, both for lenders and for borrowers, and the suitability assessment processes of brokerages arranging private mortgages and/or engaged in private lending.
What we found
In private mortgage transactions, many brokers and agents take on a larger advisory role, whether it is finding the right financing solution for a borrower or finding the right mortgage investment for a lender. In addition, many industry veterans have informed FSRA that the suitability of a private loan to a borrower is heavily dependent on the existence and feasibility of an “exit” strategy to return the borrower to a more traditional mortgage.
While the specific practices of brokerages, brokers and agents vary, FSRA identified the following practices that are generally not consistent with the consumer protection intent of certain regulatory requirements:
Documenting the suitability analysis for borrowers
An essential principle of the MBLAA and its regulations is to ensure that a mortgage product recommended for a borrower is suitable. While FSRA’s examinations showed that brokers/agents collected information to inform a suitability analysis (for borrowers), in 22 of the 39 transactions reviewed, there were no documentation about how the product recommendation met the needs of the borrower.
There are many reasons why private lending may be the appropriate option for a borrower; these reasons may not always be as obvious or clear to borrowers as they are to the brokers/agents who recommend them. The file documentation for a transaction allows another person to use the same documents/information to recreate the decisioning process — for example, by a principal broker, for compliance purposes.
Brokers/agents who make the link between the borrower’s needs/circumstances and the product that is recommended are likely to have fewer questions if the transaction is subsequently reviewed or challenged.
Know your lender information and process
A key component of ensuring suitability is for mortgage brokerages / brokers to know as much as possible about the financial needs and circumstances of their clients (both borrowers and private lenders), as well as their goals and expectations.
Many brokerages employ the use of a “know your lender/investor” form to gather this information from prospective private lenders during the vetting/onboarding process. FSRA noted that brokerages do not always document or update the private lender’s financial needs and circumstances to support their suitability assessments, while other brokerages establish guidelines for brokers/agents to follow regarding the frequency for updating private lender information.
Private lender identity not disclosed to borrowers
FSRA noted that for 10 of the 39 mortgage transactions reviewed commitment letters presented to borrowers for signing did not identify or confirm the private lender and list the lender as “to be determined” or “TBC.” Section 26 of O. Reg. 188/08 requires a brokerage to disclose to a borrower the nature of the relationship between the brokerage and each lender under a mortgage that it presents for the borrower’s consideration, and section 27 of O. Reg. 188/08 requires a brokerage to disclose any conflict of interest or potential conflict of interest.
Without a lender secured, a brokerage cannot prepare appropriate and accurate disclosure to the borrower that meets these requirements. It is also not clear in these circumstances whether the borrower understands that a lender might not yet be secured, and the options and consequences if financing cannot be ultimately secured.
Private lending transactions differ in many ways from traditional institutional mortgage financing. In particular when a brokerage represents both the borrower and the private lender in a transaction, the brokerage (through its brokers/agents) must ensure suitability for both the borrower and the private lender.
Is your brokerage’s process ready to be evaluated through a consumer protection lens? If your brokerage is engaged in private lending transactions, or is considering entering this segment of the market, consider these findings as you map out your next steps.