Monday, August 16, 2010

Why have subprime at all?

This troubleshooter video shows the dangers of subprime mortgages in Canada. A couple bought at the peak of the market in Wetaskawin with a 0 down 40 year mortgage from Wells Fargo. They are no longer operating in Canada and the uninsured mortgage was difficult to renew with other lenders.

One thing that caught my attention is that they were offered a mortgage for 10.75% by another lender at renewal. That's almost triple a discount 5 year rate! Is there any value in a loan like that? These loans exist for new borrowers as well, like this couple's original purchase, and they typically have these higher rates. One aspect of these loans is the longer amortizations which I covered in a previous post.

But it's not just longer amortizations. These predatory subprime lenders charge a significant premium on interest rates. With higher interest rates less money goes towards principal repayment, even with constant amortization. Consider the charts below which illustrates mortgage balance outstanding over time at various interest rates amortized over 25 years.

Looking at the first five years shows the pace of principal reduction over the initial term. With a 3.75% rate the $300,000 balance is reduced over $40,000 while at 10.75% it is reduced by less than $17,000. So not only are subprime borrowers paying an extreme amount in monthly payments, the higher rates makes it impossible to tackle the balance. With the buy to rent calculations so marginal even with low rates what is the benefit of homeowership under these conditions?

Answer: None. It's a trap.


Carioca Canuck said...

The classification of SUBPRIME lending is a political tool......that is why "we" (in the literal sense of the term, as my ass still hurts from the ramming given to me by Flaherty and Carney) have it....witness what happened with CMHC. They have $770 BILLION of mortgages on their books with.......

1-A borrower with no "skin in the game" at resale time after RE commissions, a discount, mortgage prepayment penalties and RE fees......or any combination thereof.

2-A borrower with a higher TDSR than normal.

3-A borrower whose downpayment may or may not have been generated and/or accumulated over time by said borrower.

4-A borrower with a weaker credit score than normally accepted.

That is why we have subprime........politics....not common sense.

Radley77 said...

Good question. I don't know!

BearClaw said...


I believe CMHC has been too lenient in the past and could probably do even more to increase standards to avoid future foreclosures. That being said the definition of subprime I use are low credit score borrowers who fail to qualify for CMHC or separate private mortgage insurance like Genworth.

I don't know where the 770 billion dollar figure comes from. In 2009 CMHC had $472 billion of mortgage insurance. It is probably in the $500 billion dollar range now. Of the $472 billion, over 60% are in loans that have over 20% equity based on the *original* lending value. CMHC is not a significant solvency risk for the Canadian government. These loans do have some minimum standards which the loan in the video did not meet (probably credit score).

Carioca Canuck said...

Sorry, I meant $470's a typo.....

Our definitions differ and that's me subprime is anything outside of the normal 25% down, 30% GDSR, excellent credit type of scenario.......if someone needs to cosign for you (in this case the taxpayer via CMHC) you're not a prime borrower by my definition.

We bailed out CMHC back in the mid eighties FWIW.....this time around the numbers aren't something I want to contemplate.

The only reason this category of borrower exists is due to politics and the REIC lobby.

squidly77 said...

Of course CMHC isn't insolvent, it's backed by the taxpayers.
770 billion undestates our indebtness

BearClaw said...


That chart is for total residential mortgage credit. Not all of that is CMHC insured.

Right now CMHC is not insolvent. Whether they become insolvent depends on the rate of foreculsures during this downturn and their ability to liquidate them.

For example assuming a 10% default rate and a selling the asset to recover 65% of the total amount outstanding leaves 17.5 billion shortfall. I think they have 9 billion in reserves so say 8.5 billion in the hole. I think that scenario is possible but pessimistic.

BearClaw said...

And yes in that case there would be a bailout of 9.5 billion dollars