Subprime Problems on the Horizon?

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A hot housing market is pushing borrowers farther and farther away from mainstream financing and it’s causing quite the stir in the Canadian subprime mortgage industry. The source of the excitement? A growing pile of mortgage debt that’s coming from outside of Canada’s big six banks.

What’s Happening in the Market

According to a report released by the Canadian Real Estate Association today, the average price of a Canadian resale home is $369,677. Although this is the first time the average price has dropped since 2010, the figure isn’t telling the entire truth. According to CREA chief economist, Gregory Klump, the downward shift is due to a slowdown in the Vancouver market, and isn’t a reflection of the national market. “The decline in average price reflects the change in Vancouver’s sales mix, not the housing price deflation.”

Key markets are influencing the average, creating a false sense of security. According to Doug Porter, BMO economist, nineteen of the 26 largest markets reported single-digit increases from last year’s levels. Three cities, including Toronto, posted double-digit price gains over the past 12 months.

So, What’s the Big Deal?

While the market appears to be stabilizing, there’s still cause for concern thanks to recent developments at the Canada Mortgage and Housing Corporation. As the Crown corporation mandated to oversee Canada’s housing industry, CMHC handles the vast majority of the nation’s mortgages, including TD, CIBC, BMO and RBC mortgage products.

It’s no secret that the Finance Department has been tinkering with the rules surrounding CMHC-insured mortgages. However, instead of slowing down a red hot market, (the nation’s real estate market has enjoyed almost uninterrupted gains over the past two years), moves to shorten the maximum mortgage length and increase the minimum down payment have pushed borrowers outside of mainstream financing methods.

Rejection Rates

According to some sources, the nation’s big banks are rejecting close to 20 percent of mortgage applications due to new CMHC regulations. But, instead of dissuading bad credit borrowers to buck-up and save, they’re simply, heading down the street to alternative lenders for a quick fix. And yes, these are the same sort of subprime borrowers, (individuals who don’t meet traditional requirements) that caused the recent housing bust south of the border.

Exact figures concerning the Canadian subprime market are difficult to pinpoint. However, Toronto based investment Firm M Partners says Canada’s alternative mortgage market could be worth roughly $85 billion, or approximately 10 percent of the total market.

That’s pretty small in the grand scheme of things; however, if subprime lending continues to spike, policymakers may have a major problem on their hands. To put things into perspective, the Canadian subprime market is about the size today as the U.S. market was in 2004. By 2007, roughly a third of U.S. mortgages were subprime – and we all know what happened next.

While many borrowers are taking advantage of low rate mortgages, those rejected by conventional lenders are finding an easy, albeit not so stable, solution to their financing needs. If subprime borrowers fall behind on their payments, the market will have to absorb forced selling at an inopportune time… potentially leading to wider price declines.

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