Understanding The Sub Prime Mortgage Market US and Canada!

What is a sub prime mortgage?
A sub prime mortgage is a loan that is categorized as riskier in nature. The borrower would typically not qualify for a mortgage through regular, traditional channels such as major banks due to either poor credit or non verifiable or low(er) income. This market was created for the many, high risk buyers. Rates for these mortgages were considerably higher than those offered to the blue chip customers.

These loans amounted to an astounding 20 percent of the total volume of mortgages written in the United States. This represented a mind boggling one trillion US dollars.

The lenders were typically offloading these sub prime mortgages to institutions who would package them as mortgage backed bonds. The high returns offered by these bonds made them a very attractive vehicle for investment funds. There was an incredible amount of money flowing into these funds.

This was a profitable business for many - wall street brokers who packaged and sold the bonds and the debt rating agencies who received substantial fees for making the bonds appear to be solid investments. Large investment dollars were pouring in from Canada, Europe and Asia.
Good times wouldn't last forever. The combination of higher interest rates and lower home values have taken its toll on the sub prime mortgage market. The number of foreclosures are up 93 percent from 2006. Some lenders have been forced out of business because of the insurmountable losses. At the worst possible time, lenders have tightened their lending practices which make it more difficult for individuals and companies to secure credit. This restrictive lending style can have an enormous negative impact on economic growth.

What affect will this have in Canada?

One byproduct is that lenders may tighten up lending practices globally which would not be immune to the Canadian marketplace. Secondly, because Canada's prime trading partner may be heading into a recession, it may have an impact on the Canadian economy. An individuals net worth in the United States is largely tied to their real estate holdings. As prices drop, many will be more cautious of consumption patterns. This will have a detrimental affect on the economy.

Are there similar risks in the sub prime market in Canada?

The U.S. sub prime market is wreaking havoc. Do the same risks exist in Canada? There are some key differences between the sub prime markets in Canada and the United States. The total percentage of the sub prime market is approximately 5 percent in Canada which is in sharp contrast to the 20 percent sub prime market in the U.S. According to the Canadian Association of Accredited Mortgage Professionals (CAAMP), the mortgage arrears in Canada is at or near record lows of less than one half of one percent (.5 percent).

In Canada, the approach tends to be a more conservative one. There is less emphasis on gaining market share for the risky sub prime mortgage business. In the U.S., clearly the war for the sub prime mortgages, may have been a reason for some careless and wreckless loan granting. Also, the lending practice in Canada is not to use option adjustable rate mortgages for the sub prime borrower. This reduces the risk with any loan. When I say option adjustable rates or so call teaser rates that U.S lender offers, which doesn't exist in the Canadian mortgage market, what it is is you can lock in at 2.5% for the first 3-6 months, afterwards it will jump back on to the regular sub-prime rate at 6-10% whatever amount of interest the lender charges. Just imagine yourself the difference it makes on your monthly payments once the regular rate kicks in.

Adrienne Warren, a Scotiabank senior economist, believes that the Canadian housing market has been less speculative than the U.S. market. He further believes real estate investments in Canada have been by in large less active, overbuilding less prevalent and less high risk lending. A strong job market and lower interest rates should help sustain the Canadian real estate market.
Mortgage interest is tax deductible on an Americans principle residence. This is another significant reason why Americans are encouraged and motivated to buy a home (sometimes prematurely). The U.S. housing affordability is at its worst level in two decades. In Canada, affordability is still very much present as the overall real estate picture is better than the 1989 period when there was a significant spike in prices. Currently, the U.S. household debt is a staggering 25 percent higher per capita than that of the Canadian household.

The real estate market in Canada has been going strong for 9 years, and for 2007 it was a record breaking year for amount of real estate solds. It is difficult to predict when the market will show signs of a slowdown. I believe given the demand for real estate in our current market, the low unemployment figures and the availability of affordable housing, the market will continue to flourish despite the struggles of our southern neighbour.