After taking a break at the start of the pandemic, Canadian real estate has seen subprime borrowers return. Equifax data shows an abrupt uptick in the share of new mortgages going to subprime borrowers in Q3 2021. It’s still a relatively small share, especially in contrast to historic levels. However, this is the first time since the start of 2020 to see an increase, and it was a sharp one.
Credit Scores and Subprime Borrowers
If you’re not familiar with credit scores, let’s give you a 10,000 foot view of them. Equifax is one of the big consumer credit reporting agencies, and they rate your risk to lenders. Borrowers are assigned a score between 300 and 900, with higher scores being better. Low scores are a sign of poor quality, with prime being the average consumer. Those with a score below prime’s lower boundary of 660, are considered subprime.
Credit scores are a combination of credit “experience” and payment history. Older accounts with no missed payments contribute to higher scores. New accounts and/or missed payments tend to drive scores lower. Under normal circumstances, missed payments are a strong sign of future delinquencies.
High Credit Scores Don’t Mean What People Think They Do
Close the Mail app, personal finance and insolvency experts. We know there are a lot of caveats about credit scores, and that “under normal circumstances” part is a big one. In a period of extraordinary circumstances, all bets are out the window.
The US during the subprime mortgage crisis is a good example. It was a subprime crisis, so the assumption is borrowers with subprime credit were the issue. In reality, subprime consumers defaulted at a similar rate to pre-Great Recession. Many of those borrowers kept making payment, right through negative equity. Some of them have only recently emerged from underwater.
Recent research shows investors with high credit scores surged in defaults during the Great Recession. They defaulted at much higher rates than usual, largely on investment properties they no longer wanted. Investors used subprime mortgage lenders to get more leverage than banks would give. It’s not as easy as blaming people with bad credit, though. So there’s been little effort to ever correct the narrative.
Low credit scores might indicate who won’t pay you when the economy is good. In a downturn, consumers with high credit scores aren’t as reliable as normal. They can all of a sudden default, especially if those consumers are investors. It turns out owners that might have nowhere to go if kicked out, try really hard to pay their bills. Investors that try to compromise repaying lenders a fraction of what they borrowed? Not so much.
Canadian Subprime Borrowers Showed A Big Uptick Last Quarter
Canadian subprime home buyers are back and consuming a larger share of home sales. Subprime borrowers were behind 4.4% of new mortgages in Q3 2021, up 0.5 points from the previous quarter. It’s a sharp increase and the largest share since Q4 2020.
The share of subprime borrowers is still lower than usual. However, the past quarter is the first uptick since Q1 2020. That was when lenders began to do everything they could to avoid missed payments. An increase in this share while the system is rigged to only increase credit quality, is worth noting.
Every Province Has Seen An Uptick In Subprime Real Estate Buyers
Every province across Canada has seen a rise in the share of low quality borrowers. PEI showed the sharpest jump, with 5.3% of new mortgages going to subprime borrowers in Q3 2021. This is up 1.6 points from the previous quarter.
Large upticks were also seen in Manitoba (6.4% of mortgages), New Brunswick (6.0%), and Saskatchewan (5.0%). Each of those markets saw an increase of 0.6 points in the share of new mortgages to low-quality borrowers.
The Share of New Mortgages Issued To Subprime Borrowers In Canada
The percentage of new mortgages in Canada that are issued to subprime borrowers.
Source: Equifax; CMHC; Better Dwelling.
The share of subprime mortgages is still low, and it doesn’t mean rising defaults. A rising share of low-quality borrowers, when the system is rigged to send credit higher, is an odd one though. Higher quality borrowers may not find low rates as enticing as they did when they were first slashed. But people with a less-than-stellar reputation for payment history see this is as a good time to buy.
Rising defaults also don’t happen in hot markets, since defaults are a result of liquidity. In a market where you can list and sell in a few days, there’s little reason for a delinquency. Borrowers that can’t afford payments are more likely to walk away with a huge profit than default.
If rising rates slow home sales, this can turn into a different (and more concerning) issue.