Will US housing crisis affect Canada?

Gillian Pritchett

The US housing crisis hit the headlines last year when thousands of American homeowners were faced with the harsh reality of not being able to keep up the high repayments on their homes. Tragic scenes of people moving out of their homes became commonplace. The worst affected have been holders of ‘subprime’ mortgages, typically lent to borrowers with shaky credit. According to the Mortgage Bankers Association, some 5.82% of all mortgages are now delinquent, the highest since 1985. Adjustable rate mortgage loans (ARMs) represent a disproportionate share of the foreclosure starts and while subprime ARMs represent 7% of the loans outstanding, they represented 42% of foreclosure starts during the fourth quarter of 2007. RealtyTrac, a company that tracks foreclosures, has over 650,000 foreclosure properties available for resale. The areas worst affected are in the Midwest, where the subprime bust is battering an industrial economy already in long-term decline, but even more economically robust states such as Florida and California are feeling the impact.

The knock-on effects are significant: since the process of repossession takes a year or more, delinquent borrowers have little reason to look after their homes, which then reduces the value of other properties nearby, and a glut of repossessed houses dampens prices by adding to the supply of homes for sale. It is not only borrowers who lose but also lenders, with major mortgage lender New Century Financial going bust in February of this year and HSBC issuing its first profit warning in its 142-year history as a result of losses incurred on subprime loans by its American division.

According to Jean Freed, MBA, a Montreal financial advisor and consultant, there were three principal causes of the crisis. Buyers overborrowed on homes they couldn’t afford. Lenders approved risky borrowers and then divested that risk by selling the mortgages on the financial markets. Another factor was predatory lending, where people were seduced into believing that if they stretched themselves for about three years they could make a financial killing and, with the resultant profit, buy another home outright.

Could this happen in Canada? While the mortgage market is equally unregulated here, and ‘no document’ mortgages are available whereby a self-employed person can declare their earnings without documentary proof, Freed considers it unlikely that the same phenomenon will occur in Canada. As to the impact it may have on Canadians, anecdotal evidence suggests that rental prices are now much higher in Florida – a favoured haunt for snowbirds. But for those seeking to buy, now is the time to secure that condominium at a very reasonable price. Freed emphasizes, however, that with much of Florida located on a flood plain, buying flood insurance is an essential. As for the broader effect on the Canadian economy, the housing market is starting to slow in Canada, and exporters to the US are likely to see a decrease in demand. Freed’s view is that while there are downsides, the overall impact is unlikely to be severe in Canada.

Jean Freed, MBA offers financial consulting services for small business and wealth management strategies for investors. For more info visit jfreed.ca.