SUB-PRIME INTEREST RATE CRISIS:

Considerations for prospective Buyers and Sellers

 

 

Housing Market Crash!  Price Drop in  Homes Expected!  Job Losses !  Worst Prices in 50 Years! Economic Downturn!  Recession Predicted to Last!

 

I open the paper or watch the news and we seem to get bombarded with abysmal, apocalyptic predictions about our economy and our future.  We all know that the world is currently going through an unstable economic period.  There are downturns in almost all markets world wide.  We, as a world wide community, face quite a number of challenges as we navigate our way through the first part of the 21st Century. Technology and increased inter-governmental infrastructure brings the worlds economies together.  We are able to trade across borders and around barriers faster, safer and less expensively that ever before.   We are quickly approaching the true realization of a Global Economy.

 

The United States is the world leader for democracy, capitalism, prosperity and market dominance.  Canada is the United States closest trading partner and the vast majority of our exports are sold in America.  Our economy is so closely tied to that of the States that "when the United States catches cold, Canada sneezes!"  The United States is currently battling, what some economists have described as, the greatest challenge of the past 5 generations.  The value of the American dollar dwindles.  Competition with other markets, where supplies and material costs are equivalent but labour costs, drastically lower than America's, cause an outsourcing of supply of products and services to markets outside the G7.  The War on Terrorism is a massive drain on American money and resources and restricts the availability of popular markets.  One of the most important American markets affected by the recent downturn (and other considerations) is the housing market.  

An understanding of what has happened in the U.S. and why, I believe, it cannot happen in Canada may help alleviate concerns about the health and strength of the Canadian Market.

 

Sub-prime Woes:

The term sub-prime does not mean that the interest is below current market values, on the contrary.  Sub-prime is a term that describes the classification of a borrowers credit.  Typically sub-prime loans are given to borrowers who are in one of the following three categories:

 

                               1.  Credit score is below an industry approved average (approximately 620 Beacon)

                               2.  The loan to value ratio is above 80:20 (the loan is greater than 80% of the value of the property/item)

                               3.  Verified earnings (the borrowers earnings have a debt service ratio above industry standard 32% in Canada)

 

In 1980 laws removed State restrictions and enacted tax changes making sub-prime loans attractive to both lenders and borrowers.  Mortgages (ARM loans) with deceptively low teaser rates are given to borrowers with poor credit ratings and/or high loan to value ratios.  The banks then sold these mortgages to 2nd party banking agencies and the mortgages are packaged as non-guaranteed mortgage backed securities.  Credit rating companies give investor grade ratings to these financial instruments.  The availability of sub-prime mortgages fuels activity in the economy and the housing market booms.  An increase in investor demand for mortgage backed securities drives a superior rate of return, making more money available to lenders and an aggressive escalation begins.  Interesting to note that the securities being given superior ratings are non-guaranteed.

 

A combination of factors leads to an increasing number of delinquencies, defaults, and power of sales.  The prices of homes declines due to job loss and economic instability.  High loan to value ratios mean that home owners owe more on the mortgage than the home is worth making sale of the home difficult.  The ARM loans explode.  ARM loans are mortgages with 2 rates.  Depending on the amortization (5-25, 3-27 or 2-28) ARM loans offer a low teaser rate for the first part of the term.  The idea was that borrowers would have time to fix their credit scores and build equity in their homes.  They would apply for conventional loans before the first of the 2 terms was up.  Because mortgages are tax deductable, borrowers paid very little toward the principle of the mortgage and paid little attention to credit scores.  ARM loans on the second term would explode to double digit interest rates and the borrowers would be stuck paying a substantially increased mortgage payment.  Some loans would more than double the expected mortgage payment overnight.

 

Crisis:

 

As housing prices decline and ARM loans explode, many sub-prime mortgage borrowers have no choice but to stop making payments.  The banks and 2nd party agencies that have bought these mortgages and sold them as mortgage backed securities receive no payments and lose money in the billions.  Lenders tighten guidelines and standards to prevent losses in the future.  Borrowers have an increasingly difficult time trying to garner mortgages.  The slow down in the market increases and housing prices continue to drop.  Another vicious circle begins and American's are not yet out of this cycle.  Barack Obama, the current U.S. President, seeks 9 billion dollars to put into the market to protect home owners and the banks and attempt to stop this downward spiral.  We will wait and see the outcome but as of February 10th, 2009 congress has approved the Presidents Stimulus Plan...

 

The Canadian Difference:

Lending institutions in Canada give out very few sub-prime mortgages.  We, as a country, have a more conservative view of savings and lending criteria and the variety of mortgages we provide.  Our mortgages are not tax deductable so Canadians tend to pay more towards the principle of our mortgages.   As more money goes towards the principle, loan-to-value ratios increase, making debt decrease.  The average resale price for homes in major Canadian cities is forecast to increase where the trend in the U.S. is still mixed.  In Canada federal financial laws make it mandatory for all high ratio mortgages (those with loan to value ratios above 80:20) to be secured with mortgage insurance.  Mortgage insurance mean less risk for the banking institutions.  In Canada there are no ARM loans. We have no interest only mortgages. Our maximum loan to value mortgage is 100%.  In the U.S. there are mortgages where you can borrow 125% of the value of your property.

 

The differences in our economy, market and laws all combine to ensure that the sub-prime interest rate crisis is almost impossible to duplicate in Canada.  

 

 

 

For more information please feel free to call me @ 647 228-8565

 

David Hopkinson

Sales Representative and Accredited Green Agent

Coldwell Banker Terrequity Realty