You know the type of person that defaulted in the US crash in 2008. Big McMansion, two trucks, and an underwater mortgage. At least those are the people the media focused on. They didn’t quite cover how smart of a move it may have been for some of those people to default. The states with the highest number of defaults were states with non-recourse mortgages.
A non-recourse mortgage is one that limits your personal liability, and makes for strategic defaults. For most Canadians, when the price of your home drops, you’re still liable for the full amount you paid. You’ll probably have to borrow from your savings or retirement and pay the difference. Then you can sell it and move on, accepting defeat at the real estate game with a lot less money in your account…except in some US states and Alberta. In these places, many people can default with liability limited to the home and a hit to their credit score.
The above chart is a scaled index of Canadian real estate prices vs US real estate prices.
US Defaults (2008-2010)
12 US states have laws that ensure mortgage liability is mostly limited to the house. That’s right, your car, your savings, your retirement are pretty much untouched. The bank gets the house that isn’t worth as much as they lent you, and you may get a black mark on your credit history. You can even get a government backed mortgage in three years for a new home if your credit history is decent. These “simple folks” who were defaulting on their mortgages seem a little more sophisticated now, don’t they?
Mailing the keys in (called “jingle mail” in the industry), is actually a pretty smart idea for some. Enterprising Americans actually built a cottage industry around teaching people to strategically default. Helping them understand whether or not it was a financially viable move.
This is largely why Canadians and Europeans don’t default. If you default on your mortgage, the banks can move to seize assets to help recoup the mortgage money. Your RRSPs, your savings, your kid’s education plan – all at risk if you don’t pay your mortgage. In cities like Toronto, default rates barely moved during the crash in the late 80s. People still lost a lot of money, but they kept their homes.
The one notable exception is Alberta, the only province to offer non-recourse mortgages. These are 20% down, non-government insured mortgages that the bank is mostly on the hook for. The borrower’s liability is limited to the home, except for a mark on their credit history. Today there’s a lot less advertising around these non-recourse mortgages so a lot of people in Alberta don’t realize their mortgage may be set up this way. The government of Alberta intentionally created this system to help people deal with oil patch volatility.
This doesn’t mean the Fed and banks aren’t worried about it. In 1983-1984, Alberta mortgages in arrears spiked to 3.2% – 300% higher than the rest of Canada noted National Bank of Canada Senior Economist Marc Pinsonneault.
Sidenote: It’s also interesting to note that the Bank of Canada’s recent reports remove the 80s from their arrears publishing. Probably just a coincidence. I wonder if it’s the same coincidence that many real estate boards in Canada start historical records after the last crash.
The double standard of moral obligation is interesting. Companies break contracts routinely when they deem them unprofitable, but individuals are held to a social obligation. Middle class, well earning professionals are often portrayed as buffoons if they default on debt, but tycoons like Henry Ford, P.T. Barnum, and Donald Trump are deemed shrewd business people when they do it.
The majority of Canadians aren’t looking for bad mortgages, but now that Canada’s real estate bubble is larger than the US one, a good portion are going to find them. It’s an unfortunate circumstance, but not one reserved for people that are reckless with money. Many of the people that default on loans might be richer than you think.
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