Differences Between Canadian and U.S. Mortgage Markets

December 9, 2009

photo by Elocity

The Canadian mortgage market underwent many structural innovations and changes in recent year, mainly during 2006 after the federal government liberalized mortgage insurance. Mortgage innovation was needed in Canada, but has been relatively more conservative than in the U.S. Nowadays, as a result of these changes, the Canadian mortgage market differs from the U.S. in the following ways:

• Canada’s subprime market is much smaller compared to the U.S. Not only it is small, but it isn’t really subprime per se. It acts more like a “near-prime” market, whereas the U.S. market more often lends to borrowers with extremely impaired quality. Since the quantity of new subprime mortgages in Canada didn’t reach the lofty numbers seen in the States, Canada wasn’t as exposed to these products which caused most of the damage in the U.S. housing market.
• Canada does not offer adjustable rate mortgages, in contrast to the U.S. The closest product is the variable rate mortgage which is constantly repriced so people aren’t disadvantaged years later. Also in Canada, for some variable rate products the principal, not the payment is adjusted. Adjustable rate mortgages caused many financial problems in the U.S. housing and banking sectors where they are sometimes sold to consumers who are unlikely able to repay the loan should interest rates rise—extreme cases are characterized by the Consumer Federation of America as predatory loans.
• A mortgage equity withdrawal is the decision of homeowners to borrow money against the appraised value of their property. In Canada, this type of borrowing was less common than it was in the U.S. at the peak of their housing market.
• The enforcement of Canadian mortgages does not favour the borrower as it does in the U.S. In some jurisdictions, mortgage loans are non-recourse loans: if the funds recouped from the foreclosure sale of the mortgaged property are not sufficient to cover the outstanding debt, the lender may not have further recourse after foreclosure. In other jurisdictions, it is the borrower who remains responsible for any remaining debt. In the U.S., lenders have very little recourse; the same goes for Alberta and Saskatchewan in Canada (the rest of Canada does provide for lender recourse).
• The tax deductibility of mortgage interest against income dampens somewhat the U.S. mortgage industry. Not present in the Canadian mortgage market, it creates a higher incentive to purchase mortgages.

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  photo by Scot Campbell

  The introduction of insured investor mortgages in Canada in 2006 led to the increase of purchases in this segment although it doesn’t quite reach the U.S., U.K., or Australia market levels. Investor mortgages originated in the States, and according to experts from Scotiabank Group, account for about 9% of all outstanding mortgages; similar numbers are had in the U.K. (9.5%) and Australia (10%).

• Canadian mortgages are funded, underwritten, and enforced in a totally different manner than that of the U.S. The majority of mortgages are held (accounted for) on the balance sheets of Canadian financial institutions, thus many mortgages are funded by on-book retail deposits, prompting banks to offer more conservative financial products.
• Mortgage-backed securities (MBSs) are a type of derivative where issued mortgages are packaged up and sold to third parties, and most are issued in the U.S. Unlike the U.S, Canada did not account for MBSs in off-balance sheet SIV and CDO structures, resulting in lower heavily leveraged investor risks. A major cause of the financial problems in the U.S. was the leveraging of these repackaged mortgages.
• The NINJA (“no-income-no-job-no-assets”) mortgage was a very popular product offered by U.S. banks, contributing to the “straw that broke the camel’s back,” which led to the 2007-08 mortgage crisis. By not checking incomes, verifying job statuses, and requiring sales contracts, U.S. banks were participating in poor lending practises. There were no NINJA-style mortgages in Canada since Canadian bankers kept strict qualifying rules.
• Scotiabank estimates that in Canada, home equity is equal to almost 70% of residential property values, which means that total mortgage debt is only about 30% of the total value of Canadian homes; this home equity position is stronger than it was a decade ago (about 66%). In the U.S., on the other hand, there has been a sharp erosion of home equity, which began during 2001-02. By 2004, well before the start of the U.S. crisis, the equity position had already seriously eroded.
• Most Canadian mortgages remain on the lenders’ books, so there is a strong incentive to maintain high credit standards. Only about 6% of Canadian mortgages are held by special-purpose corporations and non-depositary intermediaries. The U.S. underwent a widespread securitization that eventually caused a breakdown in the incentive to control risk. Credit quality was abandoned when it became clear that mortgage originators would not have ultimate accountability for credit quality.

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