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.

The 40-year mortgage

Longer amortization is becoming more popular in Canada. Here is what RBC had to say about longer term mortgages.

Longer amortization mortgage products are a large and growing share of monthly mortgage originations, particularly in the high ratio mortgage segment. This development has unfolded within the past year and a half as the market has gone from standard 25-year options towards 30-, 35- and 40-year mortgages.

With a 40-year mortgage the amount of equity built through payments is very low. With a $300,000 loan at 6.25% it works out to about $3,600 after 2 years. Probably less than property taxes an owner would have to pay. Also combined with a high ratio mortgage it takes YEARS to pay off the insurance using a 40-year mortgage. With $30,000 down the CMHC insurance is $7,800 for a 40-year and $6,000 for a 25-year.

Not building equity too quickly paying mortgage insurance for 4 years.

Combination Income Loans

There is an article in the Edmonton Real Estate Weekly magazine regarding combination income loans. This loan is for people who overlook the following from Revenue Canada when filing taxes:

If you received tips through your employment and they are not included on your T4 slip, report them on line 104 of your return.

The article clearly describes how this type of tax oversight can be problematic when applying for a conventional mortgage.

However, it is very unlikely that most individuals who are paid in tips or cash declare their entire income on their annual taxes, so right out of the gate this method of qualifying has a number of possible ways to go wrong.

The solution:

Because of these increasing obstacles, a number of non-conventional lenders are recognizing this growing problem and offering employees alternatives beyond just that of declaring more income to the tax man.

It is interesting that Revenue Canada and the law are considered to be "obstacles". The article also warns of the dangers to wait until you can prove your income:

As we have seen in Edmonton, house prices can change dramatically over a period of two years, making it a potentially costly decision to wait until you have the perfect income documents to show the bank before you get into the real estate market.