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Monday, March 27, 2023

What the rise of private mortgages means for the housing market

More Canadians are taking out private mortgages and holding on to them longer, posing a risk to the real estate market, according to a recent report. Some mortgage brokers warn the trend could have serious repercussions, including a possible wave of defaults as overextended borrowers grapple with rising rates and expenses.

In Ontario, private mortgages soared 72 per cent to $22.4 billion in 2021 from $13 billion in 2019, according to the report from the Financial Services Regulatory Authority of Ontario (FSRA).

“That’s an enormous number,” said Ron Butler, mortgage broker of Butler Mortgages. “It’s impacting how many homes default.”

Around 20 per cent of mortgages in Ontario are now through private lenders, said Ron Alphonso, president of Mortgage Broker Store. Of that group, he forecasts the default rate will be approximately five to 10 per cent. A default is when a homeowner can no longer make their monthly mortgage payments.

The number of clients who are unable to renew their mortgage will be three to five per cent, he added.

“If you can’t renew you need to either sell your home or you’ll go into a power of sale,” he said — instances where homeowners are forced to sell because they can no longer service their mortgage

The most recent available data shows that in 2021, 10.6 per cent of new mortgages were private, which has likely increased in 2022 after the Bank of Canada raised the overnight lending rate, making it more difficult for prospective homeowners to borrow from the banks.

Around two per cent of mortgages default in the GTA, but the increase in private mortgages is pushing the number in the range of 3.5 per cent to four per cent, Butler estimates.

Typically, prospective homebuyers have turned to private mortgage lenders when they’re unable to qualify at a Canadian bank. It can be a more attractive option as private lenders don’t require a stress test, unlike federally-regulated banks.

In a stress test, buyers must prove they’re able to afford a mortgage rate two per cent higher than the current rate. Combined with higher home prices, inflation, and the Bank of Canada rate hikes, qualifying at a bank is becoming increasingly difficult for some, experts say.

For a private lender, the central determining factor to give out the loan is the borrower’s equity, or total assets — whereas banks evaluate equity, income, and credit.

“People don’t go looking for private mortgages, but when they don’t qualify with a bank they seek alternative methods,” said Huston Loke, executive vice president, market conduct, at FSRA.

It’s easier to take out a mortgage with a private lender but it comes with elevated interest rates, meaning the mortgagee is highly leveraged and therefore, vulnerable.

In the GTA, around 50 per cent of power of sales listed come from the private lending space, Butler said.

The loan usually lasts one year before the homeowner needs to renew or decides to move to a bank. The Financial Services Regulatory Authority of Ontario recommends the loan should not go on for longer than two years, due to high interest rates.

“A private mortgage should really only be seen as a temporary option for one or two years until someone’s finances improve,” said Loke. “The borrower needs to be aware if they don’t have options to exit the mortgage they could be accumulating interest at a rate much higher rate than they would with a traditional mortgage.”

But the private lending space isn’t the only sector at risk. Defaults are also expected to increase with traditional mortgage lenders, Alphonso said.

In November 2022, 0.07 per cent of 2.2 million mortgage holders missed their mortgage payments, according to the Canadian Bankers Association.

If the default number rises to 0.3 per cent, which is a moderate scenario, then 6,601 mortgagees could default in any given month. If defaults rise to 0.6 per cent (which hasn’t happened since the mid-1990s) in a worst-case scenario, then 13,203 mortgagees default in any given month, which could harm the overall real estate market, Alphonso said.

Defaults are still low overall, but often the reporting lags by a few months and in four to eight months, the picture will become clearer, experts say.

“This will be a really rough year because as more people are unable to pay back their loans, we’ll see more defaults and power of sales hit the market,” Butler said. “We are seeing it right now; private lending is at the forefront of power of sales.”


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