Home buying has never been a particularly inviting and reassuring process for most, but recently there’s been plenty of discussion in the media about the role high-risk borrowers play in making the financial lending pillars a little too shaky for the big banks’ (and the economy in the bigger picture considering the role housing plays in it) liking.
The question here is how are traditional borrowers doing across Canada? Not so long ago, the Bank of Canada updated Canadians on how low-ratio mortgage originations did in the previous year, 2016. In their quarterly report on vulnerabilities and risks, the growth of low-ratio mortgages was called out. It would seem that well-leveraged home buyers represent a significant portion of the purchasing whole, and that mitigates much of the risk for banks. However, these buyers are – not surprisingly – taking out significantly larger loans much more often, and the way that increases amortization terms is posing risks for real estate markets.
Here at RealEstateLeads, we offer a valuable tool that provides a way for realtors to get more listings, but we understand that sharing knowledge with those agents in order for them to make buyers ever more qualified for the life-altering purchase they’re about to make is definitely beneficial as well. So let’s discuss this recent concern regarding traditional mortgages.
Low-Ratio Mortgage Borrowers
A low-ratio mortgage borrower is a buyer who has a significant down payment when buying a home. Sometimes called a “traditional” mortgage, it will typically stipulate that a 20% down payment is required. According to the BoC, a low-ratio mortgage borrowers averages a 30% down payment at this time. These are the least risky types of mortgage holders. Or in theory at least.
These types of borrowers continue to be the client of choice, but the BoC has been taking notice of the risks associated with their borrowing preferences. First off, after a 35% down payment, income documentation rules become “less stringent”, as the bank puts it. Part of that means income verification is not undertaken. That’s not a particularly pressing issue since the likelihood of a home’s value dropping by 35% is fairly unlikely, but it’s a possibility nonetheless and some would say it’s more possible than ever before and particularly in specific locales.
The average loan-to-income rate across Canada for low-ratio mortgages saw minimal growth throughout 2016. A loan-to-income rate is exactly what it sounds like – the ratio of the amount borrowed on a mortgage in comparison to the amount of income generated by the household. 3 years ago this number was 271%. One year later, it had jumped to 292%, a 7.74% change. 2016 saw it increase to 296%, a 1.36% change. This should be regarded as a positive, but it should be noted this is across Canada. In-demand markets like Toronto and Vancouver are burdened by markets that many people would figure have no correlation.
Low-Ratio Average Loan-To-Income Above 450% Is Growing
One specific risk highlighted by the BoC is the number of low-ratio mortgages with a loan-to-income ratio that stands above 450% is growing. In 2014, the number of low-ratio mortgages had a loan-to-income above 450% was only 12%. By 2015, that number leapt to 15% of all mortgages. In 2016, the total of low-ratio mortgages above that 450% loan-to-income mark was sitting at 17%. It continues to grow, fuelled in large part no doubt that Canadians have shown themselves to have little to no fear of extreme housing debt, or being ‘house poor’ as the term goes.
The BoC is quite justified in their concern about this segment, and for a pair of reasons. The first is the sheer size of loan, while the second is the documentation of income. When your loan-to-ration tops 450%, there are inevitably going to be doubts about your ability to keep up with the payments. Further, when they’re low-ratio mortgages, it’s not unlikely that income wasn’t verified as stringently as perhaps it should have been. Should the borrower haves a significant change to their income or a change in ability to withdraw income from another country, there’s a real potential for big-time problems.
The risk to the lender isn’t all that prominent in such an instance, but the issue is that it threatens the equity of neighbouring homes when it happens repeatedly. Unfortunately, the nature of the market means the stage is very much set for that to happen in specific regions.
Low-Ratio Mortgages Are Taking Longer Terms
Another growing trend is low-ratio borrowers choosing longer amortization periods. In 2014, 42% of low-ratio mortgages had terms that stretched longer than 25 years. In 2015, that number jumped to 46%. Now, the number for low-ratio mortgages with amortizations longer than 25 years is 51%. It’s a growing trend, and one that obviously would be troubling to lenders.
It has the potential to be particularly problematic because of low interest rates. Mortgage rates are already at historic lows, but any type of significant uptick could be very tough for the borrower to absorb. One could increase the length of their mortgage, but that length of amortization may not be available in the future. Should that be the case, you would have to take a shorter amortization and increase your payments dramatically. Not difficult to see where this is going, and why it could be potentially devastating for borrowers.
Yes, the risk associated with these types of loans are likely exclusive to overheated markets like Toronto and Vancouver. They don’t present much of a concern to banks, on account of the cushion applied to down payments.
The concern should rest exclusively with the homeowners, and those prospective homeowners may be your clients. Be sure to have a reputable mortgage broker / advisor on tap to recommend to your clients, and do consider signing up for RealEstateLeads here to get qualified online-generated buyer and seller leads delivered to you exclusively for your specific region of the country.
