The Subprime Sub-plot

As I write this article the media is full of stories on the alternative lending or subprime market in the United States. One edition of the Wall Street Journal had so many stories on the subprime sector that it looked more like a special mortgage insert.

Here in Canada both the minister of finance, Jim Flaherty, and Bank of Canada governor David Dodge have weighed in on the challenges to the Canadian credit market as a result of the U.S. subprime meltdown. Let’s deal with the facts.

The subprime crisis is very much an American story. Rising interest rates, the extensive use of adjustable-rate mortgages, low introductory rates that reset higher after two years, a real estate market where prices are actually declining and, yes, lax lending practices all impacted the U.S. mortgage market.

Default rates began to rise. By the third quarter of 2006, over 7% of U.S. subprime mortgages were in default or had missed more than three payments. The subprime default rate increased further in 2007.

According to USA Today, over 40,000 people employed in the mortgage industry lost their jobs. The Mortgage Lender “Implode-O-Meter” website told of 186 lending operations wiped out.

The troubles in the subprime mortgage market spilled over onto Wall Street. Rising default rates got the attention of investors. In the credit market, mortgage lenders who securitize or “sell” their mortgages couldn’t find buyers. Investors were forced to re-examine their risk tolerance. A very real liquidity crisis developed that affected the stock markets to the point where the U.S. Federal Reserve stepped in, lowering its discount rate by half a point. Central banks around the world, including the Bank of Canada, pumped money into the market to help stabilize the situation.

This is where the Canadian mortgage market felt an impact. Investors and purchasers of mortgages all over the world began to lose confidence in subprime or alternative mortgage products. In short, new mortgages had trouble being financed. Some Canadian lenders decided to vacate the alternative mortgage market altogether, meaning less choice for borrowers.

It is important to note that alternative mortgage products do have a place in the market. Subprime refers to an individual’s credit history. New Canadians or the self-employed, for example, may not have a strong credit history, but do have good, stable income. Such products allow potential homebuyers to enter the real estate market sooner and build equity.

Borrowers always need to do their research and ask questions of a professional when finalizing their mortgage. They need to know the pros and cons of what a variable-rate mortgage means to their individual circumstances. With the Internet and other resources available, it’s easier than ever to gain information on mortgage products. Buying a house is often the most important financial decision a person will make. It’s not to be taken lightly.

A major difference between the U.S. and Canada is that the real estate market, particularly in western Canada, is healthy. In constrast to the housing price drop in the U.S., record home prices here were set on almost a monthly basis. The Calgary and Edmonton markets last year saw average home prices increase by nearly 50% year over year. While prices have leveled off in 2007, the market remains healthy.

Overall, Canadian employment levels remain strong with unemployment at a record 35-year low. Interest rates remain historically low and average income levels continue to rise.

Underwriting practices in Canada are also more thorough. Adjustable-rate mortgages are less common. Canadians are just plain more conservative with their mortgages. Statistics from my organization, the Canadian Association of Accredited Mortgage Professionals, show 70% of this country’s mortgages are fixed-rate while arrears rates remain low.

While Canadians always need to monitor happenings in the U.S. market, it is also important to note the differences. America is experiencing a real housing and mortgage slowdown, but Canada – and Alberta in particular – have set themselves apart with a strong economy and a healthy
mortgage market.

Between the Lines is a guest column about current affairs topics that touch on business in the province. Jim Murphy is president and CEO of the Canadian Association of Accredited Mortgage Professionals.

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