A recent report from U.S. investment firm Morningstar warns that Canadians may not be immune to the housing crash our neighbours south of the border have experienced. One troubling reality of Canada's housing market is the lack of strong, transparent data. How many more buyers might default if interest rates shoot up? How might plummeting home values impact Canadians? It's not entirely clear and that's frustrating for mortgage brokers and real estate insiders alike.
Some say that Canadian cities such as Vancouver and Toronto are being over-built. But while they are crowded, I think that investing in real estate in these cities would be a good idea because the supply of land is limited.
While Canada is by no means excluded from a potential market crash like the one Americans saw in 2008 and the years following, it's not an immediate threat. Here's a look at two key differences between mortgages in the U.S. and Canada, plus how they might protect us from a crash.
•Tighter underwriting standards. Prompted by the lessons learned from the American housing crisis, Canadian lenders and the Canadian government have tightened lending standards. Equity lending -- where you take out a loan on the home equity you've built up -- is now almost obsolete.
Until a few years ago, borrowers were almost guaranteed a mortgage if the deal was conventional. Lenders are now looking at more than just the down payment, especially the ability for the purchaser's income to cover debt
With stricter income verification, self-employed borrowers are facing a bigger challenge to qualify for a mortgage. Many clients who purchased homes for or five years ago are having a hard time rate shopping and transferring their mortgage; the income that qualified them for the original loan may not qualify under the current guidelines. Those looking at buying an investment property are shocked to hear they need a higher income, because the rental offsets (the amount of rent the lender will add to your income) are much lower than they've been in the past.
Stricter underwriting means those applying for a mortgage now are more qualified and have a lower default risk. Canadians had a lower default rate than our U.S. neighbours even before these changes took place. Back in 2008, 4.5 per cent of U.S. mortgages were in arrears compared to only 0.3 per cent of Canadian mortgages, according to the Canadian Home Builders' Association.
In addition, the American tax code incentivizes large mortgages through mortgage interest deduction, while the Canadian system does not. Lastly, Canadians tend to choose a fixed interest rate over a variable one, which is more conservative and often allows the buyer to plan their budget more effectively.
•Shorter amortizations. The maximum amortization period on an insured mortgage in Canada is 25 years. In the United States, it's still very common to amortize an insured mortgage for over 30 years. With a shorter amortization, more of each payment goes towards paying off the principal sooner. If property prices fall, borrowers are in a better situation with a smaller mortgage. Even if they need to sell the home, a smaller mortgage allows them to retain some equity or at least cover their expenses so that they are not out of pocket.
Amortization is also important if interest rates rise. With a really long amortization, borrowers can be in deep trouble at renewal, because higher interest rates lead to larger monthly payments. For people who are over-leveraged, these higher payments can be enough to send them into foreclosure. Often someone who is over-leveraged in his or her mortgage may also have high credit card debt, making the situation even worse.
Buyers, developers, and lenders should be conservative in case interest rates rise or property values decline. That being said, there's no need for buyers to lose sleep over a market crash that may or may not happen.
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