The number of people that shouldn’t be purchasing Toronto real estate, but are buying anyway, is skyrocketing. At least that’s the consensus from the latest high-ratio mortgage data we scored from the Bank of Canada (BoC). According to these statistics, more people are entering into high-ratio mortgages, and they’re doing it with a high loan to income ratio as well. The combination makes these buyers perfect candidates for defaulting on their mortgages.
High Ratio Mortgages
High ratio mortgages are ones with minimal equity in the home (i.e. the down payment the buyer had was really small). The industry defines a high ratio mortgage as any mortgage with a loan-to-value ratio of more than 80%, which basically means anyone with less than 20% down. These types of loans have little risk for the lender, since the borrower also has to pay the cost of securitization (a.k.a. they have to buy default insurance). Keep in mind, the default insurance the borrower is required to purchase actually covers the bank in the event of a default, not the borrower. The borrower still assumes all risk.
Experts say you should have a loan-to-income ratio of less than 300%. In plain english, this means your mortgage should be 3x your gross income max (less if you have significant debt). If you make $100,000/year, and want a $400,000 condo – you should have $100,000 as a downpayment (25%). Any less, and your chances of carrying that loan become increasingly more difficult. If you’re high leverage, and have a mortgage over 300% of your annual income, you’re at a large risk of default. If that ratio exceeds 450% and you’re also a high-ratio borrower on top of it, the odds are stacked against you.
Toronto Seeing More High Leverage Loans With A High Loan-to-Income Ratio
Recently, Toronto has seen a massive increase in people who have high leverage loans, and also have high loan-to-income ratios. According to the BoC, “almost half of the high-ratio mortgages originated in Toronto in the third quarter of 2016 had LTI ratios exceeding 450%.” That’s right, 49% of high ratio mortgages also had a dangerous loan-to-income ratio. The same quarter in 2015 saw 41%, and that quarter in 2014 was just 32%. So the loan quality has been rapidly deteriorating over the past couple of years.
Spreading Beyond Toronto
The problem isn’t just isolated in Toronto, it’s spread to surrounding cities. Oshawa and Hamilton both saw high-ratio mortgages with high loan-to-income ratios more than double in the past 3 years. BoC analysts saw the ratio increase from 10% to roughly 25% over that time. Now I know Oshawa is the Manhattan of Eastern Ontario, but I’m not sure a high-leverage mortgage that’s out of your budget is a smart idea.
The quality of loans deteriorating rapidly over the past two years should be a sign of how healthy this market is… or isn’t. Toronto real estate prices have had a thirty year run, without much resistance. Suddenly over the past two years, people that shouldn’t be buying houses are scrambling to get into the market. These buyers are taking out loans they’re likely to default on. Since they’re insured, banks have little to no risk, but as I mentioned above, the risk still falls on the buyer. Unfortunately, this doesn’t just impact the people who are taking out these risky mortgages, it’s contributing to rising prices for responsible homeowners as well.
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Map Sources: Department of Finance Canada; Postal CodeOM Conversion File (PCCF), 2016; Statistics Canada Catalogue no. 92-154-X; Forward Sortation Area Boundary File, 2011 Census; Statistics Canada Catalogue no. 92-179-X; Google; and Bank of Canada calculations, Better Dwelling.