Why Canadian homeowners are likely just as vulnerable as Americans were - Macleans.ca

Why Canadian homeowners are likely just as vulnerable as Americans were

It’s scary


Ben Rabidoux is is an analyst at M Hanson Advisors, a market research firm, where he focuses on Canadian mortgage and credit trends and their implications for the broader economy. He blogs regularly about the housing market at The Economic Analyst. Follow Ben on Twitter @BenRabidoux. 

If you listen to our banks, Canadian homeowners have nothing to worry about. According to Scotia’s latest housing outlook, for example: “Canadian household balance sheets remain in reasonably good shape, with homeowners’ equity in real estate assets averaging 67% compared with 41% in the United States.” In other words, if the average Canadian family were to sell their house at current market prices and pay off their mortgage, they’d be left with an amount equal to 67 per cent of the value of the house. An American household, by contrast, would be left with a mere 41 per cent. Sounds reassuring, no?

It certainly does. But how useful is it to compare Canadians’ equity in an overheated housing market to Americans’ equity in a post-bust real estate wasteland, where homeowners are paying off mortgages on houses whose value has collapsed?

Reading between the headline numbers: The unsettling truth

What we should be comparing isn’t Canada today to the U.S. today, but rather Canada today to the U.S. at the peak of the housing bubble there. As you can see in the chart below, Canada is sitting at roughly 67 per cent average homeowner equity compared to 60 per cent in the U.S. just before the bust.

Canada is still marginally better off, but that’s really no reason to pat ourselves on the back. Here’s why:

1) First of all, unlike Canadians, Americans can deduct the interest they pay on their mortgage from their taxes, which explains why Americans have traditionally carried more real estate debt than us. The same mortgage is simply more affordable in the U.S. than in Canada based on a similar income.

2) A standard U.S. mortgage term is 30 years while in Canada it is five years, meaning U.S. homeowners are much more sheltered from the risk of rising interest rates. This also represents a massive incentive for U.S. homeowners to take on larger mortgages and not pay them off as quickly as Canadians, who must be continually cognizant that interest rates and hence payments may reset substantially higher at their next mortgage renewal.

3) Finally, despite the fact that housing prices in Canada have been climbing for the past 10 years or so, Canadians’ home equity is lower today than in was in 2000. This speaks quite strongly to how down payments have deteriorated over time and home equity withdrawals via refinancing have spiked. Even the U.S. managed to perform better than us on this front: There average equity positions held steady up to the peak of the housing bubble. And note that these calculations do not include Home Equity Lines of Credit, which are nonetheless a claim on the equity of the home. (I address this point in detail below.)

4) The calculations both Statistics Canada and the Federal Reserve use to measure average equity include households with no mortgage as well. This becomes problematic when one tries to compare Canada to the U.S. because significantly more Canadian households own their homes outright than Americans do. According to the Canadian Association of Accredited Mortgage Professionals, an estimated 39.2 per cent of Canadian households have no mortgage at all. According to the 2007 American Community Survey, by contrast, only 31.6 per cent of Americans own their homes mortgage-free. All this means is that Canada’s equity numbers are skewed upwards, masking the potential vulnerability of Canadian owners with a mortgage sitting at the bottom of the credit pyramid. If we could strip out households with no mortgage from both Canada and U.S. estimates, I suspect we would find that the equity position of Canadian households looks remarkably similar to that of the U.S. at peak. And it’s this group, after all, that we are most concerned with.

The other ‘minor’ detail many are overlooking: HELOCs

It’s also important to note that neither the U.S. nor Canada include HELOCs in estimates of owner equity, which is rather odd given that they nonetheless represent a claim on said equity. In Canada, in particular, where the Bank of Canada estimates total consumer credit amounts to roughly $486 billion, HELOCs have been by far the fastest growing form of consumer debt in the country over the past decade.

Most importantly, the size of outstanding HELOC debt compared to GDP in Canada dwarfs that in the U.S. Data from the Office of the Superintendent of Financial Institutions indicates that chartered financial institutions in Canada hold $206 billion in HELOC debt. (And note that this does not include credit unions and other lenders that are not federally regulated financial institutions.) This amounts to roughly 12 per cent of Canadian GDP. By contrast, in 2010 a report by consumer reporting agency Equifax estimated that there were about $649 billions worth of HELOC debt outstanding in the U.S., or only about four per cent of GDP.

The take-away: 

The average Canadian household with a mortgage is in substantially worse shape than a cursory reading of the numbers would indicate. If we could strip away all non-mortgaged households and factor-in HELOC debt, we might find that the balance sheet of Canadian households looks remarkably similar to that of American families just before the housing market crash.


Why Canadian homeowners are likely just as vulnerable as Americans were

  1. This is all well and good, but how likely is it that Canada will have a real estate crash as widespread and severe as the U.S. did in 2008?

    • The US crash was regionally focussed, as will the eventual crash in Canada: BC lower mainland, Victoria and the GTA.

    • I think that is the point of the article! He’s saying that prices have been rising, and our ability to pay the increased prices has only been because we are getting further into debt, it’s not that there is increased wealth, our wages have not increased. These are the same ingredients that started the US crash.

      • The same ingredients, sure. However, in 2008, the U.S. had enough of those ingredients to bake a cake the size of Manhattan. And then Bear Sterns went under. And then Lehman Brothers went under. And then AIG almost went under, and almost took the entire global financial system down with them.

        Not that the global economy couldn’t still completely melt down, but in that context, I think housing prices will be the least of our worries.

  2. Writing from the US, I can tell you that the Canadian situation is different. With the exception of the first time CMHA purchase, Canadians usually put at least 20% down on their homes, rather than the little or nothing that some of the underwater people in the states put down on their homes. CMHC also requires that Canadian home buyers qualify on a standard loan product, even if they do want a graduated payment mortgage or interest only mortgage. Canadians also don’t have 30 year fixed rate mortgages, so they tend to pay off their homes sooner, because they don’t want to be caught in a jam when their rate adjusts every seven years. For these reasons, there are a lot less underfinanced home owners in Canada and it would take a lot more for their homes to go underwater.

    • If Canadians “usually put at least 20% down”, there wouldn’t be a CMHC, and it most certainly wouldn’t be a $600B behemoth. This is simply not accurate.

    • Canadians cannot pay off their homes sooner, obviously, because their homes are so expensive. Canadians do not earn more than Americans.

    • CMHC’s own data (housing market survey from early 2011) showed that about half of home-buyers in the previous year put down less than 20% on their purchase. Among first-time buyers, the vast majority take high-ratio mortgages. I believe the average down-payment for first-time buyers is about 7%.

      I’m also not sure that Canadians pay their homes off sooner. This may have been true in the past, but a CAAMP survey from this spring indicated that only about 30% of mortgage holders had made an additional payment in the preceding year.

    • Not many first time buyers can put down 20% for an average $350,000 ‘house’.

    • To fix your facts on Canadian Mortgages.

      The average down payment is 7% in Canada, not 20%. We had cash-back downpayments for the approximately the last 6 years.
      We used to have 30, 35, and 40 year mortgages. This has JUST changed back to 25 year mortgages in July 2012.
      The interest rate adjusts every 5 years, not 7.

  3. It’s really hard to compare Canada to the situation that occurred in the US. There are a number of different factors that were present in the U.S. that are not present in the Canadian scenario. Canada is also heeding warning signs well right now – taking measures to help ward off potential for real bust situation. This is all while areas of the country are still growing and producing very well – showing signs of economic stability. If you’re considering an income property investment, the opportunity is alive an well with great growth potential in many provinces…

    • We are only growing now thanks to an overstimulated housing market (which has a big impact on jobs), plus large Provincial and Federal govrenment deficits that are pumping excessing demand into our economy with debt fueled spendng. Completely unsustainable. When things do return to normal (balanced budgets and home building that matches population growth) we will get our recession (or depression?).
      The only reason the US is growing is due to their Trillion $+ annual deficits which cannot go on forever, and even with that amount of overspending many are calling for a recession by end of 2013.

      • and also remember that the main reason Canada fared well since 2008 is the stimulus programs from the US, China, and global wealthy countries to artificially fuel growth and increase demand for our resources.

  4. Good job Maclean’s. I also noted that Scotia was concluding that Canadians were ok because their house prices are currently high (they have a lot of equity) compared to Americans.

  5. Yet another misinformed blogger! Chmc is insurance, which means it backs the loans.
    The US had zero down mortgages that could be walked way from with no insurance.
    Not even close to the same circumstances.
    Shameful………. Sensationalistic…….. Empty, no accurate or relevant data to even compare it.

    • Not everyone in the US could walk away. The areas that people couldn’t had to declare bankruptcy if they were too far into negative equity. That put the brakes on consumer spending in many places.
      Also thanks to CMHC and Genworth (guarenteeing high risk loans in the $850 Billion range), if people do default banks see no financial loss and taxpayers are 100% on the hook for loses. It’s too bad we didn’t fraudulantly rate them as AAA and dump them on global investors.
      Insurance has zero impact for the average borrower, it just protects the banks.
      Also need to consider that the US FED has been dumping Trillions into their housing market and banks to shore them up and prevent the housing market from truely correcting. Yes it’s different here but the outcome can still be as bad or worse then the US one as i don’t see our BoC willing to print endlessly to cover the loses or stimulate more lending.

    • Recourse laws are state-by-state in the USA. I don’t know where people get the idea that any American can just walk away from their mortgage without penalty. Mortgage loans are non-recourse in about a dozen states. In the rest of the US, they are recourse, like they are in Canada. The mortgage lender can come after your other assets, garnish your wages, etc. to make up the shortfall.

    • Non-Recourse in the few non-recourse states in the USA only applied to purchase money first mortgages (not the common 80/20 loans, not refinances) and practically everyone at risk of default refinanced at least once during the bubble valuations or used an 80/20 package if they were explicitly sub-prime.
      So the recourse versus non-recourse argument is somewhat of a red herring.

  6. If your total debt model is that you owe 50% of the value of the house after 20 years because you have paid your kids tuition, cars and wedding… Bought a sports car and remodelled (highest HELOC Borrowing is for renovations ) for the long term occupancy in that house. Now you are at the cottage?

    So what? Really! So what?

    We have a retiring demographic you have completely ignored.

    Living in Toronto When will detached house prices come down? They will not decrease as long as we have inbound population, safe haven for banking, jobs and politics, first rated universities and health care. Highest educated workforce in Canada… indicate to me a Clear shortage of supply of homes in the 416 and 905 areas…

    Yes there will be an oversupply of condos in 2014 and 2015. Those buyers need to be more prudent.

  7. Note that this is NOT an exhaustive analysis of similarities/differences
    between the housing and mortgage markets in Canada and the US. MUCH more can be written on that front. This is simply
    addressing the shortcomings of one chart which appears regularly in research notes on the Canadian housing and mortgage market and now seems to have formed a
    central pillar in the “it’s different here” thesis.

  8. This fear-mongering is a good way to get your magazine picked up off the shelf and nothing more. The US crash happened due to a credit bubble where loose lending standards allowed unqualified people to get mortgages. These people later defaulted because they could as in most states they’re not personally liable… they can just give the house back in what’s called a strategic default. Now Canadians are capitalizing with http://www.AmericanHomesFund.com.

    • i know a bunch of people who are unqualified to have the mortgage that they have.

      “hey Darla let’s sell our house and git us a bigger one”
      “k Clem and then with the money we make we can go git us one of them der flat screen TVs”
      “Right Darla and then we can take out another 30 year mortgage and start over from scratch. By the time the kid are 50, we will own our house”

      Voice of Reason: What if interest rates go up or unemployment becomes a problem?!? Inflation could cause the first and global issues could cause the second.

  9. You guys have been writing this gloom for years and nothing has happened except a steady rise in most peoples equity. Sad fear mongering to sell magazines.

    • How has Vancouver’s market been lately?

  10. As long as the exponential growth in property prices keeps up with lines of credit and mortgages, no problem right? Oh wait, does that mean our incomes also need exponential growth?

  11. Folks, it can happen. The real issue isn’t what the “average” equity in a home is, its the amount of equity (or not) for those homeowners on the margins. Markets are made at the margins, not in the middle. What percentage of home/condo owners have less than 10% equity? If market prices begin to drop (they’ve dropped 13% in Vancouver in the last year), those mortgages are suddenly under water (home is worth less than the mortgage). If the market begins to collapse, those folks with no mortgages won’t be forced to sell, but their Net Worth (on paper) will decline, and the inverse wealth effect kicks in. As several commenters noted, there are two primary risks for the Canadian residential real estate market: an increase in unemployment and rising interest rates. Either, or both of those events could trigger a decline in housing prices, which causes those on the margins to default, which leads to foreclosures, which leads to further price declines….and the downward spiral continues downward. In a falling market, who will step in and “catch a falling knife”? Only a circus performer I suspect. The challenge is, once that downward spiral begins, there’s nothing to stop it (buyers disappear) until it hits the ground with a giant “thud”. Banks will no longer lend because they don’t trust appraisals and they will have enough REO on their books, thank you. Cash buyers will rule, and lenders will lend only to those who don’t need the loan. Those whose mortgages go underwater may keep paying their mortgage if they still have the income to do so (remember those rising interest rates?). Those who are underwater and have no other assets that a bank may go after, may just walk (strategic default) and take the hit to their credit rating. Better that than paying off a mortgage that is worth $200,000 more than their house. Can a collapse happen? Yes. Will it happen? Only with one of the many triggers. Just be aware. Don’t over leverage your home. Its your home after all, not a margin account at a stock brokerage. And do you REALLY NEED that SubZero or new BMW?