Lenders sticking to low LTV mortgages

Shield Mortgage Capital’s Jason Geall says the private mortgage market during COVID-19 is seeing lenders tightening up credit criteria and sticking to low loan-to-value mortgages.

It’s been a wild few months, to say the least. As a millennial, I have obviously never seen anything like this in my lifetime, but I think the most concerning thing is that our parents who where born during or just after Second World War have also never seen anything like this. It is a time we will never forget.

Right now, the issue is the unknown. When will a treatment come out? When will a vaccine work? Will there be a second wave? Those big unknowns add up to massive uncertainty surrounding what the economy and market will look like in the short and long term.

Today, we are discussing a market that I work in on a daily basis, the real estate and mortgage market. Our company, Shield Mortgage Capital, is a Toronto-based private lending company that specializes in providing equity-based lending in the Greater Toronto Area.

Market predictions all over the map

Needless to say, as a company that lends money against real estate, we are constantly monitoring the situation to make sure our loans are still safe and strong. There is a lot of speculation as to what the real estate market in Canada is going to do. Everyone has an opinion.

If you ask realtors, they will likely tell you the market is going to continue to go up. If you ask CMHC (Canada Mortgage and Housing Corp.), a government organization that provides unbiased research and advice to the Canadian government and housing industry among other things, they will tell you that home prices will drop between eight per cent and 19 per cent in the next 12 months. However, in a late-April report from TD, the bank predicted home prices in Toronto could rise 7.8 per cent. National Bank of Canada, on the other hand, has forecast an average fall of 9.8 per cent from 2020-21.

For the sake of contrast and context, prices dropped 6.3 per cent during the 2008 recession and 9.2 per cent during the 1981 recession. These are scary numbers, but not quite as scary as the 25 per cent decrease in home values that Alberta and Saskatchewan are projected to see.

Mortgage deferrals causing concern

Next, let’s talk about the state of the mortgage market. The Big Six banks deferred a total of more than $180 billion in mortgage payments on residential mortgages during the three months ended April 30.

That represents more than 14 per cent of the $1.24 trillion in residential mortgages the chartered banks have on their balance sheets. However, that is still a lot less than the $300 billion that the Big Six have offered in payment deferrals on credit cards, personal loans and commercial mortgages.

These numbers are causing concern among almost all experts. Evan Siddall, the CEO of CMHC, warned a parliamentary committee in early May that a looming mortgage “deferral cliff” could happen this fall as borrowers lose jobs and repayment does not resume. To quote Mr. Siddall: “As much as one-fifth of all mortgages could be in arrears if our economy has not recovered sufficiently.”

If this were the case, you would see an influx of real estate hit the market, which would drive the market down. (Remember US housing prices in 2008-09?) The private mortgage market was also affected, but seemingly not as badly as the Big Six have been.

For one, the private mortgage market in Canada makes up about 10 per cent of all mortgages, so the market isn’t quite as large. Private mortgages are also typically short-term and often include prepaid interest from the loan amount. This means that monthly payments are not required from the borrower.

That doesn’t mean deferrals weren’t granted. We offered deferrals to borrowers who requested them, and did notice a slight uptick in cheques bouncing. However, most by the next month were caught up. According to Statista, private mortgages in 2019 ran at a 1.65 per cent default rate, compared to the banks’ 0.23 per cent.

Mortgage lending rules tightened

COVID has changed everything, but let’s look at how it will change mortgage rules. Starting last Canada Day, July 1, CMHC’s new mortgage rules took effect. The new rules demand higher credit scores, from 600 to 680. They also reduce the amount a borrower can borrow based on ratios: total gross debt service (TDS) falls from 39 per cent to 35 per cent and total debt servicing to 42 per cent from 44 per cent now.

This will make it extremely hard for borrowers who have less than 20 per cent to put down on a property to qualify for CMHC mortgage insurance. You might ask yourself, how many mortgages does this really affect? Well, 35 per cent of mortgages in Canada, or one in three, are CMHC-insured. These changes will greatly affect a borrower’s ability to purchase a home.

Here is an example: a family with an annual income of $100,000 that has a 10 per cent down payment would currently qualify for a home valued up to $524,980. Under the new rules, that same family would only get approved to buy a home worth $462,860. This is a 12 per cent decrease, which will massively change a borrower’s buying power.

As private lenders, COVID has massively changed our lending criteria also. We have reduced how exposed we will be on properties by 10 per cent to 15 per cent, looked for stronger borrowers in terms of credit, and changed where we will lend.

Excellent opportunities await

What does this all mean for investors? If real estate prices correct by nine per cent, there could be some excellent investments to make. Real estate has always been considered a safe investment, so if you are a long-term investor, keep your eyes open over the next year.

There could also be an opportunity to purchase cottages and vacation properties as they are the first things to go on sale when there are economic crashes. If you are someone who enjoys investing in private mortgages, keep your eye on loan-to-value (LTV) ratios. Staying in low loan-to-value mortgages is going to be our strategy over the next 12 months to 18 months, with a strong focus on borrowers who work in industries uninterrupted by COVID, as well as knowing what the exit strategy is.

I believe it is important to be contrarian in these times. Look for good investment opportunities in areas that you know and trust. Coronavirus isn’t going to be around forever and things will eventually get back to normal.

Jason Geall is the CEO and co-founder of Shield Mortgage Capital Inc., a private lending company based in Toronto. Their website is www.shieldmortgagecapital.com. If you have any questions or comments, Jason can be reached via email at jason@shieldmortgagecapital.com. The preceding article is an opinion and is for information purposes only. It is not intended to be investment advice.

This is an edited version of an article that was originally published for subscribers in the July 17, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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