Mortgage Markets — U.S. vs. Canada

Canadian-US-mortgagesSkeptics have analogized Canada’s mortgage market to the U.S. market ever since the American bubble started to burst.

And in the 5-6 years since, there have been few better rational comparisons than Benjamin Tal’s report released on Monday.

Tal, a CIBC economist, admits that all is not well with Canadian housing. Yet, he adds, “…Any comparison to the American market of 2006 reflects deep misunderstanding of the credit landscapes of the pre-crash environment in the U.S. and today’s Canadian market.”

We’ve taken his comparison of the two countries and boiled them down into digestible bullets.

To begin with, let’s start with what doesn’t insulate Canada from falling prices.

Tal begins by challenging some commonly-cited reasons why Canada is different, including:

  • The U.S. mortgage interest deduction — Tal suggests this U.S. tax benefit played only a limited role in stoking the U.S. housing bubble. The absence of this rule in Canada is not a major saviour.
  • Lender recourse — Canada’s recourse system (which keeps people on the hook after foreclosure) does “not provide a full shield from a substantial fall in prices,” he says. In the U.S., only 12 states have no-recourse laws and “there appears to be no significant difference in housing market performance between recourse and non-recourse states.”
    • That said, there is conflicting research suggesting the probability of default is actually up to 20% higher in non-recourse states. Moreover, U.S. borrowers in recourse states regularly default anyway, for reasons like this. Lenders often don’t pursue deficiency judgments on these people due to the legal process, costs, uncertain recovery, etc. When you default in Canada, lenders send the hunting dogs after you, and their teeth are long…and sharp.
  • Canada’s low arrears rate — We can’t take too much solace in Canada’s minuscule default rate says Tal, who writes, “In a short eighteen-month period in 2007-08, the serious mortgage arrears rate in the US surged by more than 300%.”
    • Albeit, the U.S. arrears spike was largely caused by underwriting that was near-criminal (and often criminal). As well, Canada’s arrears rate has long been less than half that of the Americans’ (even pre-2006) thanks to conservative lending practices.
  • Rate Sensitivity — Canadians are more vulnerable to rate hikes than the average American because our terms are far shorter (5 years versus 15-30 years).

Benjamin-TalTal then goes on to list the reasons Canada is different:

  • Less subprime — The U.S. crash was a subprime story, he concludes. Remove subprime and it would have been a “soft landing.” Subprime and Alt-A mortgages were 1/3 of originations in the year before the crash, and 20% of outstanding mortgages. Eighty per cent of those had risky floating rates. In Canada, CIBC pegs non-prime at just 7% of the market.
  • Skin in the Game — One-third of U.S. mortgages in 2005-2006 were already in negative equity. More than half had less than 5% equity, thus “making [Americans] highly exposed to even a modest decline in prices,” he says. In Canada, only 15-20% of new originations have less than 15% equity. Moreover, negative equity is virtually non-existent (although, that could change quickly!).
  • No teasers — Millions of Americans got teaser mortgages with rates that reset a few hundred basis points after 2-3 years. Two trillion dollars worth of mortgages reset in 2006-2007 alone. Canadian lenders don’t qualify borrowers at teaser rates. Borrowers must prove they can afford higher rates in advance.
  • Tighter housing supply — Canadian housing starts have exceeded household formation by only 10% in the past decade. That number was 80% in the U.S. before its crash.
  • Inconclusive Debt-to-income — “…As any economist knows, [the debt-to-income] ratio is more a headline grabber than a serious analytical tool,” Tal states. Various countries have had higher debt-to-income ratios than Canada and have experienced nothing “remotely resembling” the U.S. crash.
  • Better credit — Canadian credit scores have improved in the past four years. By contrast, in the four years heading into the great recession, the ratio of “risky” U.S. borrowers rose by 10+ percentage points and comprised 22% of the market.

“To be sure, house prices in Canada will probably fall in the coming year or two,” writes Tal. But it won’t be to the same extent as—or for the same fundamental reasons as—our neighbours to the south.

Here is CIBC’s full report.


Sidebar: This is an interesting graph from CIBC showing how variable rate mortgages have plunged in popularity since August 2011.

 

Variable-mortgage-originations


Rob McLister, CMT

  1. Great article Rob. Kudos to Benjamin Tal for an excellent well-balanced report filled with top-notch research and facts.
    Naturally, the response from the bears has been predictable. Rather than refute Tal’s facts and research, they’ve gone straight to the ad hominem, anecdotal and straw-man bin to pull out the usual retorts; ie. Ben Rabidoux: Tal is a banker, CIBC has high mortgage exposure, bank-employed analysts can’t write bearish notes…blah blah blah.
    The funniest one I could find goes to Garth Turner though, who writes in his self-described pathetic blog today… “I like Benny Tal. Always have, and we’ve met often. But I think he needs to get out more…Asking prices are no longer demands, but wishes. Toronto houses that went for 115% of list last year now sell for 90% – which is a drop in street value of a quarter.”
    How can you argue with logic like that? Yup, the former Minister of National Revenue just “proved” that the Toronto market is down 25%.
    Are there any facts or stats from Turner to support such a ridiculous conclusion? – Absolutely not.
    How about an example or an interesting anecdote? – Nada.
    Facts beat hyperbole, sensationalism and fear-mongering hands down.

  2. Please, from CIBC with the highest housing asset weighting in the banking sector, right after Moody’s downgrade announcement. No vested interest there.
    The popularity of Variables didn’t plunge, “Approvals” did. (lower amorts. and higher qualifying rates tipped the scale to cheap fixed rates). Great, but what about the huge number of variables coming up for renewal? Had a 40, 35 or 30 yr amort high ratio or maybe a Business For Self “Stated Income” / Alt-A mortgage? Too bad, it’s payment shock time. Renewing next year when rates are even higher. It gets worse.
    The most accurate part:
    “Rate Sensitivity — Canadians are more vulnerable to rate hikes than the average American because our terms are far shorter (5 years versus 15-30 years).”
    A key point echoed by Robert Shiller, the Yale professor who predicted the US crisis:
    http://business.financialpost.com/2012/09/21/canada-heading-into-a-slow-motion-version-of-the-u-s-housing-bust-robert-shiller/

  3. No mention of the US Fed being able to significantly reduce the interest rates to ease the pain during thier crash for those underwater (which helped reduce people’s mortgage payment by ~30%+, and negating the teaser rate impact). How about no limits on CMHC backed mortgages (+cashback ontop), now it’s at $1 Million, Fannie and Freddie had a cap of $417,000 in 2006. Most people don’t grasp the massive market intervention the US did to lessen the extent of their crash, we won’t have the ability to act in the same magnitude here if things to get bad. The US could have been much worse and I still believe we could be just as bad or even worse as it was in the US.
    I still find it funny we call it non-prime here instead of sub-prime, but then we quantify it in a different way and use it in a direct comparison.

  4. You are not very informed about variable rates. People are avoiding variables because the rate discount has disappeared. We used to get prime minus .90%. Now we have prime minus .35%. I’d say that affects their popularity. Qualifying rates are a tiny part of fit and amortization changes affect *all* terms.

  5. US cut theirs by 100bps and then again by 400bps. we have 75bps of room and even then there is little hope lenders will pass those savings on to the borrowers if thier books are starting to look too risky or if their loan growth turns negative hurting profits.

  6. I know the easier solution – forfeit all debt and start over :)
    The rich won’t loose much as they’ll gain again as the system restarts :)

  7. Only 4% of CMHC’s high ratio mortgages are over $550,000 and less than 0.4% of those are in arrears. What do you hope to prove by trimming the max. loan amount?
    I’ll never understand how people can make policy recommendations with so little understanding of the market.

  8. Here’s some recent info on US prime vs other loan type delinquency rates (http://www.mortgagebankers.org/NewsandMedia/PressCenter/81589.htm). Prime mortgages are by far the largest segment, so 4.25% of those in some state of delinquency is pretty scary. The US crash was most definitely not just a subprime story, though the subprime stories were the juiciest and tended to get the most attention.
    >>> The seasonally adjusted delinquency rate increased 17 basis points to 4.24 percent for prime fixed loans and increased 14 basis points to 9.19 percent for prime ARM loans. For subprime loans, the delinquency rate increased 52 basis points to 19.85 percent for subprime fixed loans and increased 44 basis points to 22.60 percent for subprime ARM loans.

  9. That is in an upward price market, where price gains can basically offset people’s mortgage problems (just refinanice!). You won’t see the true arrears numbers untill prices stabilize or start to decline, this eliminates the ability to go the ATM route. And i really don’t want to get into a debate on CMHC (taxpayer backed risk) that provides a guarenteed 20% loss cushion to the banks. If it’s only 4% then why bother even issuing them, there is a reason some banks are now imposing higher downpayment requirements and price limits on non-insured mortgages (location specific and lower then CMHC’s limits too!). Are banks seeing risk where CMHC does not?

  10. Why even allow mortgages over $300,000? Let’s discriminate against those who are better off and give all the benefits to low income people.

  11. Property value, in isolation, has no bearing on default risk. Credit and ability to debt service are the crucial variables.

  12. @Mike The drop in variable poopularity over the last year is of little consequence. See #Affordability of the 40, 35 & 30 year amm mortgages taken over the past 4 to 5 years renewing into a MUCH more restrictive mortgage market. Compounded by higher loan-to-values due to lower home prices [pushing more into high ratio territory] and inevitably higher rates. Even the die hard variable fans will be hit by all of the above plus much higher qualifying rates [likely pushing them into a fixed rate sooner or later]. See #Affordability #GonnaGetUgly #10YearFixed

  13. payment shock? it makes no difference if someone is in a variable or a fixed at 2.99% unless interest rates rise rapidly. When it comes up for renewal, the applicant ends up with the best rate he can get at that time. Who knows where things will be after a 5 year term? I say get the lowest rate you can now and pay your mortgage like it were a higher rate. Some luck out and some don’t. Some get burnt and others don’t. It depends on when you entered the rate cycle and where you ended up after 5 years. I would rather take the discount rate now and take my chances. Based on the world economy, rates are not changing anytime soon.

  14. Yes, payment shock. Rates don’t have to increase tomorrow. They’re not the only problem facing borrowers. QUALIFYING for “best rate” is the growing problem. You seem to assume payment increases are based only on a variable to fixed rate difference today for only qualified borrowers. The rules have changed significantly. 25 year amortizations, higher qualifying rates, lower Loan-to-Value ceilings. It’s much easier for borrowers to slip into non-qualifying and/or high ratio space.
    Kevin, if you were a lender, would you send out a “best rate” Renewal Offer to a borrower that you know probably can’t shop around? Or that would need to pay a CMHC insurance premium because their home value decreased and now they’re mtg is above 80% LTV? Or how about someone that originally qualified on an equity program that has since been eliminated? ANYONE WHO’S RECEIVED THAT RENEWAL FORM LETTER FROM A BANK PRE 2006 KNOWS THE ANSWER.. POSTED RATES. When values go up, lending loosens and pencils sharpen. When values go down, lending tightens, etc. So now you’ve got a borrower with a 35 year amortization variable rate & payment renewing into what? For qualification, the 35 to 25 yr amortization difference is a 25% payment increase. Assuming their service ratios can withstand that, now they have to qualify at the BOC 5 yr rate (currently 5.24%) and that’s again assuming their loan-to-value didn’t drift above 80%, requiring a premium on the entire loan amount.. effectively putting them right back to their Renewal Offer (if they received one). Assume they had a good discount like Prime-.70 (2.30%) and assume they’re with a major bank (most have a 5 yr Posted Rate of about 5.25%). That borrower’s payments will more than double. Now before that’s pounced upon with smoking calculators and alternate scenarios including rare re-payment disciplines, this example isn’t intended to be exhaustive or academic. Of course it won’t happen to everyone but it will happen. The number and affordability of borrowers effected will determine the extent of our collective housing problems. Incidently, for many a Variable Rate Mortgage was just fine over recent years. There was/are some savings to be had. However the exposure has increased while the savings compared with today’s cheap fixed rates has diminished greatly. The risk of paying back short term savings with a higher rate over a longer period of time is very real. Waiting for rates to increase or other market factors to add ill effct isn’t a solid plan unless you’re an extremely solid borrower with a fail-safe plan. It’s interesting how many of those plans I’ve come across lately that are predicated on misconceptions of how restrictive lending can get. Keep in mind the one’s handing out advice are not the one’s lending the money. Mortgages for good and bad are intended to be long term arrangements and should be planned out accordingly. They’re not day trading. Leaving some to luck out and some to get burnt is rather poor advice.

  15. @Susie
    Way to exaggerate.
    The truth is, if you got a 35 year amortization five years ago, you’re at 30 now. At renewal you’ll have countless lenders willing to take your mortgage.
    You apparently have a crystal ball based on your “much higher” rate prediction. I’m not as gifted a clairvoyant as you but I don’t think rates will rise more than 1-2% in the next five years.
    Even if they do, just take a 5Y fixed if you have to. If rates rise 2.25%, your qualifying rate will be the same then as it is today.
    Sure maybe a small percentage of people can’t qualify elsewhere and have to renew with their old lender. Well, they should have been better qualified in the first place. No one said buying a house is risk-free. At least they won’t be reapproved, reappraised or out on the street.

  16. “Countless lenders”?? A handful remaining (for now). ASSuming the mtg isn’t or hasn’t become high ratio ..AND other debt hasn’t been added ..AND household income hasn’t changed ..AND it wasn’t a discontinued equity or stated income program ..AND etc etc etc. Very myopic predictions for someone without a crystal ball. When OSFI took Mandatory Re-Qualification at Renewal off the table (for now) half the country breathed a sigh of relief. Of course banks are reviewing their portfolios for non-qualifying borrowers. It’s a growing list. Especially in areas with decreasing values and/or slower employment sectors. If you were a lender you would too. It’s common sense. Which unfortunately isn’t too common lately amongst overly confident “Advisors” like Bankr. Who of course won’t be helping out when your payment increases. But would like the opportunity to talk with you next year if you stayed in a variable or in 5 years at the Very latest if you go fixed. Whatever lol

  17. You’re agenda has corrupted the truth. All kinds of lenders take 35 year amortizations on assignment, high ratio or not. CMHC doesn’t consider them refinances.
    If people add debt or can’t show enough income, that’s too bad. It is the same predicament they would have been in 20 years ago. Debt ratio requirements have existed since the dawn of mortgage insurance.
    By the way, if you think lenders are going to forclose on renewers who have been making all their payments, you’re more deluded than I thought.

  18. No, there’s not “all kinds of lenders”. The number of ways preventing home owners from refinancing or transferring at a competitive rate has increased and continues to as values decrease and rates rise. That’s a fact.
    It’s also a fact that the largest 6 banks have 70% of residential mortgages along with the majority of borrowers that will likely be STUCK with their inflated posted rates. Susie’s comments didn’t mention forclosing. Why would a bank forclose on someone they can squeeze more interest from? That’s the agenda ‘BankR’. Banks don’t look for ways to charge less interest.. “since the dawn” of banking.

  19. Ted is also wrong about how CIBC has a “vested interest” in this. Yes, they’re a bank and so they’re already biased about the mortgage market. But mortgage growth at CIBC was stagnant for much of this year, especially after they closed FirstLine; and the bank has had to resort to measurs they never wanted to http://www.canadianmortgagesinc.ca/2012/10/cibc-opens-on-sundays.html
    Plus, Mike is right. The only reason variables went South is because people got a better deal with fixed rates. And still are, in fact.

  20. Sort of like the limits on UI, CPP, and student loans and every other social program in Canada?
    The CMHC’s mandate is to assist potential homeonwers who can’t come up with the 20% deposit. It shouldn’t be there to help someone buy a million dollar house with 10% down, instead of a 500K house with 20% down.

  21. It’s not CMHC’s job, the government’s job or your job to tell people how much to spend on their house.
    No one tells you how much you can eat, drink or smoke, even though those decisions of yours affect all of us through greater health care costs.
    The only thing you should worry about is, can insured borrowers make their mortgage payments, and 99.6% of them can.

  22. “It’s not CMHC’s job, the government’s job or your job to tell people how much to spend on their house.”
    ???
    No-one is telling people how much to spend on their house. The Government/CMHC are just limiting the social insurance provided.
    In the same way it is limited for unemployment insurance, welfare, the CPP, RRSP contribution deductions, TFSPs.

  23. I’ll side with ABroker on this one. Limiting access to CMHC insurance based on price is an arbitrary price control. CMHC doesn’t have price limits in its mandate, nor should it. It is backed by all taxpayers and its mandate is to provide housing options for all Canadians.

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