Canadian real estate and mortgage market unlikely to follow U.S. example

Last week several Canadian subprime lenders announced rate increases and a general tightening of lending guidelines, making if harder and more expensive for subprime borrowers to get loans. This was the result of an increase in lender's cost of funds due to problems in asset backed commercial paper market -- a direct impact of the collapse of the subprime mortgage market in the U.S.

At this time there is no signal that would indicate that our real estate market in Canada will follow the same path as the real estate market in the U.S. The Canadian economy is performing well, the job market is stable, the interest rate environment is generally stable and real estate prices continue to rise unlike real estate prices in the U.S. which are declining. Also, mortgage lending in Canada is far more conservative than lending has been in the U.S. Firstly, there are far fewer subprime mortgages in Canada as a percentage of all mortgages. In Canada, subprime loans account for about 5% of all mortgages vs 20% in the U.S. Further, most borrowers in Canada (approximately 2/3), take out 5-year fixed rate mortgages -- the figure is the reverse in the U.S. With a fixed a rate mortgage the borrower can count on the fact that his mortgage payment will not change for 5-years. With a variable rate mortgage, an increase in the Prime rate can impact the borrowers ability to make payments at any time. Add to that the prevalence of 'teaser' mortgages in the U.S. that gives borrowers a low rate introductory offer that they could enjoy for 2-years after which time they would have no way of making their mortgage payments and it should come as no surprise that their mortgage industry has collapsed.

Save your credit: Avoid missing payments at all costs

I frequently get calls from people who for various reasons have found themselves unable to meet their payment obligations. Whether they are having trouble making their mortgage payments, paying credit card or telephone bills, my advice is ~ avoid missing payments at all costs!

So how do you make the payments if you are short of cash? Take out a loan, borrow from a friend or family member. If you miss payments you will damage your credit. Then later, when you try and borrow it will harder to do so and more costly because your credit will be damaged.

If you have equity in your home, use it! Get a new 1st mortgage or a 2nd mortgage while your credit is good. If your cash flow problem is temporary, you will pay down the debt later when your situation is improved. If your cash flow problem is not temporary, then you need to take steps to reduce expenses i.e. downsize.

Canadian subprime lenders increase rates and tighten lending guidelines

Last week was uneventful in the 'A' mortgage market -- no significant changes to rates.

The story in the 'B' (subprime) mortgage market however, was quite different - we saw rate increases and a general tightening of lending guidelines, making it harder for subprime borrowers to get mortgages.

What are the differences between the A and B mortgage markets?

The A mortgage market is for people who can qualify for a discounted mortgage rate. Typcially, these borrowers:

- have good credit
- are salaried, or
- are tenured self employed

The B mortgage market is made up of borrowers who don't qualify for a discounted mortgage rates. They usually:

- have some credit problem,
- if salaried they don't meet the normal income requirements, or
- are not tenured self employed

Why is the A market stable while the B market is seeing changes?

The A market is stable because lending money to strong borrowers for the purpose of buying real estate in Canada is still considered a good risk. Real estate in Canada has proven a good investment and homebuyers are unlikely to give up on paying for their homes, especially if if they are personally occupying the home.

In contrast, Canadian investors are showing some hesitation to invest in B/subprime mortgages in Canada. The source of funds that feeds the subprime market is asset backed commercial paper (ABCP) and in the last couple of weeks investors have been pulling their money out of ACBP's. This has already translated into higher borrowing costs for Canadian subprime borrowers and more stringent lending guidelines.