Mortgage Foreclosure Crisis - Why it won't happen in Ottawa

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A subprime mortgage is defined as a loan given to someone with a poor credit rating or debt history, at a higher-than-usual interest rate. The borrower is often seduced by astonishingly low starting rates, which over time rise considerably, and a streamlined, high-pressure buying process conveniently handled by a third-party - the Broker. Subprime mortgages represent 20% of all U.S. mortgages.

The Broker becomes the key figure in a chain of four Bs which has resulted in the U.S. mortgage crisis. Banks use Brokers to sell loans to Borrowers. Although the Broker receives a commission for making the sale, the liability for the loan rests with the Bank. The Bank (or other lender) often repackages the mortgages as Bonds - the fourth B in the conundrum, and re-sells the Bonds to yet another party, as an investment.

That's okay as long as the value of homes rise. But when interest rates rise and home prices fall, home owners get saddled with a burgeoning debt-load, including their subprime loans - and end up owing far more than the value of their collateral (their home) is worth.

According to the U.S. Federal Deposit Insurance Corporation, insured lending institutions "added $11.4 Billion in provisions for loan losses to their reserves during the second quarter." These are the largest expected quarterly losses for the industry since the down-turn in 2002. The amount of loans and leases 90 days or more in default grew by $6.4 Billion during the past quarter alone - the biggest since 1990. 48.1% were residential mortgage loans, 34.2% were real estate construction & development loans.

The cascading effect has now hit China's state-owned banks, who have financed $11 Billion worth of subprime mortgages in the United States.

The National Association Of Mortgage Brokers in the United States maintain that Brokers have acted responsibly in following the regulations, which put the onus on the Borrower to buy a home within their means and to search for and examine any contractual fine print. The regulations also provide for a three-day cooling off period in which to cancel the contract.

The failure of these regulations to prevent the current crisis has resulted in the U.S. Congress considering changing the law to place financial responsibility squarely on the shoulders of Brokers. American home owners caught in the mortgage crisis have already begun to take legal actions.

Some home owners burdened with debt in the UK have responded by entering into an arrangement known as "Sale and Rent Back", rather than face foreclosure by lending institutions. It involves a private company buying the property as a capital investment and allowing the former owner to remain on a lease so that they don't have to move. It also involves a purchase at a price considerably lower than the actual value of the home.

This is also being done in the United States. "Desperate times", they say, "require desperate measures". U.S. lenders sent out 179,599 notices of mortgage default nationwide in July alone. And Britain is suffering from the same problems as the United States, with some exceptions. "It is the U.S. subprime mortgages that default first". One U.S. company predicts 2 million filings for foreclosure in 2007.

In comparison, only about 2% of Canada's outstanding mortgage credit is in unconventional mortgages, say DBRS Rating Agency.

There are sometimes moments when Canadians can breath a sigh of relief at the conservatism of their financial institutions that generally prevents them from following the exuberance of US money markets. This is one of those times. It is the significant factor that has prevented rashness by some Ottawa home buyers, and the factor to most likely prevent any meltdown in the Ottawa homes market.

It seems that although lending institutions across the border don't want to foreclose any more than Canadian lenders do, their opportunism to make money leads them to taking greater risks, whereas Canadian financial institutions remain conservative and risk-averse. This is arguably a consequence of the greater competition in the US financial sector.

Canada's home prices are up by 13.1% since this time last year, and buyers are described as being in a "buying frenzy" because they are afraid of being left out of the housing market. Ottawa new home prices are up only 2.1% on average however, since Ottawa prices were already higher than most other Canadian cities.

The average price of a home in Canada reached $332,442 in July, according to The Canadian Real Estate Association. And CMHC was obliged to raise its sales predictions due to an unexpected surge of sales this summer. They now predict that 2007 will be a record year. Instead of sales gradually declining, as first predicted in February, they are actually rising.

One element driving new sales in the Ottawa housing market is the recent changes that CMHC made to the way mortgages are calculated, which lending institutions were quick to take advantage of. Canadians can now amortize their mortgages over 40 years - instead of the more customary 25 years - because it lowers monthly payments. It also increases the total interest due on the loan over its lifetime, however.

Mortgage rates meanwhile are being handled in a variety of ways. Britain has raised its interest rates five times in the past 12 months to 5.75% - their highest rate since 2001. The United States appear to be poised to lower rates. And Canadian institutions, on the other hand, are always ready to acknowledge the third option - to do neither, and stand pat.

Some Canadians, faced with soaring prices at home, are looking south of the border to Arizona, even California, where falling home prices now appear competitive - especially with the high value of the Canadian dollar.

But so far, opportunities for cheaper homes in the US, or even in Gatineau, for that matter, have not resulted in any stabilization or reduction of Ottawa's home prices.

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