New report warns the rate of mortgage defaults is "increasing exponentially"
On January 06, the Real Estate Investment Network, one of Canada’s largest support and education groups for real estate investors, released a report aimed at preparing both homeowners and potential buyers for a looming rise in foreclosure sales.
In How to Avoid and Buy Foreclosures, REIN’s Jennifer Hunt and Marc Moreno Pascual argue that Canada’s COVID-19-triggered economic downturn and the subsequent increase in provincial unemployment rates have placed many of the country’s homeowners “under a great deal of stress.”
“With higher than usual unemployment rates, current conditions indicate a potential rise in foreclosures along with opportunities for uniquely positioned investors to buy foreclosed properties,” Hunt and Pascual wrote, adding that “the rate of mortgage defaults is increasing exponentially.”
But according to Matt Fabian, director of research and industry insights at TransUnion, REIN’s claim of rapidly rising defaults isn’t supported by recent evidence.
“No, in fact it’s the opposite. Generally speaking, we’ve seen a flat pattern coming out of deferrals in terms of consumer delinquency overall,” Fabian told Mortgage Broker News by phone. “Certainly, with mortgages, we’re actually seeing a little bit of a drop in delinquency rates.” According to Fabian, delinquency rates at the end of 2020 were “about nine basis points” lower than a year before.
Dominion Lending Centre’s chief economist Dr. Sherry Cooper was similarly perplexed by REIN’s claims of an “exponential” increase in delinquencies or an imminent rise in foreclosures.
“The only thing I can think of is the small rise in delinquency rates in places like Alberta. I don’t think a surge in foreclosures is in the cards. In fact, Canadian household financials look quite good in the aggregate,” Cooper said by email.
“Household net worth and savings have risen considerably. Consumer sentiment is rising, and savings rates have surged. To be sure, those who are suffering from long-term unemployment will not be buying homes, but they are typically low-income earners and usually are not homeowners,” she continued.
Fears of a forest fire of foreclosures, first fuelled in February, were somewhat justified before the beginning of the country’s mortgage deferral experiment. If the economy was still in shambles when deferrals ended, many worried, how would Canadians be able to pay their mortgages? (Remember the days when the “deferral cliff” was casting a long, grey shadow over the country’s housing market?)
But Cooper and Fabian both noted that most Canadian homeowners who opted to defer their mortgages did so by choice, not out of need.
“Many homeowners took the deferral to be safe,” Cooper said. “They saved the money they would have spent on mortgage payments, and most are now making their monthly payments on time.”
While some homeowners certainly did require a mortgage deferral to ensure they kept their homes, Fabian says the vast majority were far from desperation.
“They were kind of gaming the system,” he said. “There was a huge chunk of consumers who, even though they opted to take the deferral, were still making payments.”
According to Fabian, “only about 2% of consumers” are still engaged in a mortgage deferral program.
REIN’s take on the data
Hunt stands by REIN’s projections, which she says are based on Bank of Canada data and Statistics Canada’s Survey of Financial Security.
Referring to StatCan data from 2016, Hunt pointed out to MBN that only 50% of Canadian borrowers at the time said they could cover eight months’ worth of mortgage payments using liquid assets, with only 30% able to cover four months and 20% able to cover two months.
“There’s not a lot of flexibility, not a lot of buffer,” Hunt said.
But considering average Canadian income levels and housing prices, having eight months’ worth of mortgage payments in the bank at any one time is a rather remarkable achievement, even more so when it applies to half the population. The latter two buckets Hunt mentioned are more of a problem; theoretically, at least. Nowhere near 20% of homeowners appear to be at risk of failing to pay their mortgages.
REIN’s view on delinquencies becomes more convincing, however, when the group leans on Bank of Canada projections, which say a spike in the nation’s arrears rate will arrive in the third quarter of 2020.
“The policies that have been implemented,” Hunt explained, referring to Canada’s COVID-related monetary policy, fiscal stimulus, and quantitative easing strategies, “have certainly reduced the likelihood of mortgage arrears and reduced that risk and vulnerability, but that inherent risk and vulnerability is still there. It’s just been lowered and pushed out.”
Indeed, the BoC’s projection of a Q3 spike in mortgage arrears tracks almost exactly with REIN’s decade-old Economic Turmoil Formula, an eight-stage breakdown of how real estate prices are impacted by sluggish economic activity over time.
According to REIN’s formula, it takes approximately 18 months for a dramatic drop in the country’s GDP to work its way through the housing market. Unemployment feeds population declines, which kill rent values, which lead to a rise in housing supply, which erode home prices. Eighteen months from February 2020 places REIN’s target date for real estate disruption smack-dab in the middle of Q3.
“Housing prices are the last to be affected,” Hunt said. “They’re lagging indicators. So yes, you’re seeing in many cities in Canada these frothy markets. But that’s exactly the behaviour we look for in a market that is entering a slump.”
Part of the discrepancy between REIN’s assumptions and those of TransUnion appears to be semantic. For the report, Hunt said REIN defined “foreclosure” as “when the process of foreclosure begins”, or “the day the first payment is missed.”
Mortgages in these cases, she said, are “technically in default, but it could be paid the next day, so it doesn’t go down that path.”
Avoiding foreclosure
Despite the questions raised by the data used in the report, REIN has provided a worthwhile resource for homeowners hoping to avoid the disaster of having their homes foreclosed upon. From laying out the credit score impact of foreclosures and bankruptcies to providing over a dozen options for struggling homeowners hoping to keep their homes, it’s arguably the first document of its kind created solely for Canadians.
“We wanted to demystify [the foreclosure process] so that individuals can be prepared for it, whether they’re homeowners already or investors,” Hunt said. “The bank’s M.O. is that they don’t want to have to have your house on their books. They want to work with you. If people are aware of that, they can really set themselves up for the option to negotiate. That’s ultimately what it comes down to.”
For readers hoping to find themselves on the other end of a foreclosure sale in 2020, Hunt’s advice is clear: Don’t base a foreclosure purchase on price.
“In so many cases, I’ve seen individuals who don’t do the required market research,” she said. “They get caught up in price. They get caught up in cheap real estate in a small city. They haven’t done their research and it can get them into trouble.”
Shami Sandhu, president and regional director of RealtyOne Group of Western Canada, says investors new to the foreclosure space shouldn’t hold on to fantasies of encountering a plethora of unbelievable prices.
“Typically, foreclosures tend not to be the ‘steal-of-a-deal’ that we witness on US television programs,” Sandhu said, adding that most provincial courts often encourage the sale of foreclosures for a fair market rate to assist homeowners in rescuing whatever equity they can from the sale.
“The other factor that discourages most average buyers from foreclosures is that you are typically buying the home on an ‘as-is, where-is’ basis,” he said. “The condition of the property is not guaranteed on possession day.”
