Written by Mark Weisleder or the Toronto Star
As Bank of Canada Governor Mark Carney tries to talk Canadians out of piling up too much debt, the comments have led to a lot of speculation about whether Canada faces a U.S.- style housing meltdown.
Nothing could be further from the truth. The factors that led to the US housing crisis were unique to their market. Next year should see strong growth in prices and sales, especially in the GTA, and I plan to write about why in the next few weeks.
The differences between the U.S. and Canada can be summarized as:
American politicians encouraged banks to make it easy for consumers to buy a home. The banks ended up lending to people who never would have legitimately qualified for a mortgage. Basically, if you had a pulse, you got approved.
Government programs allowed buyers to get a down payment from the government as well. In other words, many bought properties with none of their own money.
These mortgages came with very low interest payments, but after a few years, the home owner had to make a large lump sum payment. Many couldn’t afford the payment and so these mortgages were called ‘sub-prime.’
The U.S. lets homeowners deduct interest paid on their home mortgage from their income tax. Thus, whatever was paid by the borrower to carry the mortgage was taken as a deduction on their income tax returns. You can’t do that here.
Many states in the U.S. have non-recourse mortgages. This means that if you default on a mortgage loan, the only remedy for the bank is to take back the property. They cannot sue you for any loss suffered. This also doesn’t apply in any province except Alberta?
When you put this together, there was no incentive for home owners to pay down the mortgage principal. They just kept remortgaging and taking out the equity. Wall Street figured out a way to sell these sub-prime mortgages by convincing others about the great profits they would make on these balloon payments. Unfortunately, none of these balloon payments were made and most of these loans were worthless. Currently, besides the hundreds of thousands of properties still in foreclosure in the US, it is estimated that almost 20 per cent of the remaining mortgage loans are “under water,” meaning that the homes are worth less than what is owing on the mortgage debt.
While it may be true that Canadian household debt may be increasing, but with less than 1 per cent of mortgages under water, this is not the basis for any kind of housing collapse.
Here are the main differences between the Canadian and U.S. markets:
Banks have made sure over the last few years that even if you qualified for a 1-year mortgage rate of 2.5 per cent, you had to have the ability to pay the 5-year rate, which was closer to 5.5 per cent, in order to qualify for the mortgage. Thus, even if interest rates rise, as the Governor has warned, most Canadians will still be able to absorb the increased payments.
Banks have been much stricter in requiring evidence of real down payments before lending any money. There are no free down payment programs in effect in Canada.
In Canada, because you cannot deduct interest from your home mortgage on your tax return, you are encouraged to pay down the principal on your mortgage. American lawmakers want to go the Canadian way and remove the home mortgage interest deduction from the US tax code, but can’t for now as this may cause millions more to lose their homes.
Most Canadian mortgages, except in Alberta, are recourse mortgages, so if you don’t pay, you can be sued by the lender for any shortfall.
Mortgage insurance companies are working proactively with borrowers who may be having difficulty making their mortgage payments to find solutions before the mortgage goes into long term default.
The Governor of the Bank of Canada has to walk a very fine line, looking at inflation on one side, interest rates and he overall economy. There is a reason that the Canadian economy is now the envy of most of the G20 countries. It is also a reason for continued optimism for 2011. Enjoy the ride.
Real estate lawyer Mark Weisleder is the author of Put the Pen Down! What homebuyers and sellers need to know before signing on the dotted line.
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