In a time when the economy and the housing market in the U.S. lacks stability and confidence, our neighbors to the North continue to thrive. Canada’s dollar has continued to see its strongest performance in over a decade. From a record low of 62 cents on the U.S. dollar in January 2002, the currencies are now nearly equal in value.
Canadian citizens’ median net worth is nearly 50 percent higher than that of U.S. residents, though the average after-tax income is nearly equal. Perhaps even more astonishing is that while one in every 492 homes in the U.S. received a foreclosure notice in November 2011, less than one percent of all Canadian mortgages are in arrears. This alone should merit a review of what makes Canada different.
One factor in the large discrepancy in net worth between the citizens is the significantly larger amount of student loan debt carried by the average American. However, an even larger factor is home ownership. In 2009, the percentage of housing units owned by its occupant was nearly equivalent between the two countries – 67.4 percent in the U.S. v. 65 percent in Canada, though estimated higher now.
The dissimilarity, however, comes to the percentage of homeowners with or without a mortgage. In the U.S., an average of 31.5 percent of homeowners are not encumbered by a mortgage. In Canada, nearly half of all homeowners own their home outright, accounting for one cause of the virtually non-existent foreclosure market.
So what accounts for such a large divergence in homeownership and foreclosure rates? One influence may be the banking laws in Canada. The World Economic Forum has named Canadian banks as the best in the world and has continually described them as the “soundest” banks in the world throughout the U.S.’s recession. In fact, not a single Canadian bank failed during The Great Recession, while hundreds of banks in the U.S. collapsed and financial giants were bailed out.
Granted, there are roughly 100 times the number of banks in the U.S. as in Canada, but their regulations may be a bigger reason for the utter lack of failures. The home finance market may be a primary reason, as the housing market bubble burst triggered the collapse the U.S. bank failures.
In Canada, there is also no secondary market for mortgages. Mortgages are not bundled and sold on the securities market, as in U.S. where supporters argued the secondary market allowed the banks to take the loans off its books to free them up to lend more money. This practice, however, also incentivized banks to lower their standards and fueled the issuance of subprime mortgages.
Canada insists on more rigorous mortgage underwriting than in the U.S., which has prevented Canadian banks from originating subprime and no-doc mortgages. In Canada, while the loans remain on the bank’s books, the risk is passed on to government agencies. Of course, critics will argue whether such government intervention is wise, but the results still merit some analysis.
Over half of Canadian mortgages are effectively guaranteed by the government, with banks paying a low price to insure the mortgages. Essentially all mortgages with a loan-to-value ratio greater than 80 percent are guaranteed directly or indirectly by the Canadian Mortgage and Housing Corporation, as any loan worth over 80 percent of the home value requires the borrower to purchase mortgage insurance to cover the debt in case of default. Witnessing the housing market crash in the U.S., the Canadian government adjusted the rules for government-backed insured mortgages in an attempt to keep the Canadian housing market healthy and stable while preventing Canadian households from getting overextended.
As of April 19, 2010, the Canadian government required that all borrowers meet the standards for a five-year fixed rate mortgage, even if they chose a mortgage with a lower interest rate and shorter term, endeavoring to prepare borrowers for higher interest rates in the future. The amount a Canadian could withdraw in refinancing their mortgage was lowered from 95 percent to 90 percent to help ensure that home ownership is a more effective way to save. Finally, the government required a minimum down payment of 20 percent for government-backed mortgage insurance on non-owner occupied properties purchased for speculation.
One final aspect of the Canadian mortgage industry that may be a cause for greater homeownership without mortgages is that the big tax write-off that Americans are allowed for the interest on their mortgages is not allowed in Canada. The lack of mortgage interest deductions may cause Canadians to pay down their mortgage debt more quickly. Perhaps even more meaningful than the effect on foreclosure rates, the sooner a homeowner can pay-off the hefty debt of a mortgage, the sooner they can focus on saving for retirement.
In the end, what has worked for the Canadians in stabilizing its economy and housing market may or may not be effective in the U.S. The Canadian population is roughly 34.5 million people, while the U.S. population exceeds 307 million. There are only 71 federally regulated Canadian lenders, compared to the 8,000-plus U.S. lenders insured by the Fedieral Deposit Insurance Corp. Maybe the Canadian banking system can only be successful in a concentrated economy and, in the end, maybe Canadians are simply culturally more averse to accruing debt than their neighbors to the South. Regardless, it is worth examining whether a hard analysis of Canadian banking could suggest progressive alternatives to current housing financing in the U.S.•