How Did Canada Avoid the Foreclosure Crisis?

This is not the first time we have discussed the differences between the Canadian and U.S. housing markets, but it is something that probably bears revisiting. For all the similarity between our countries, Canada never experienced the housing bubble that we did in the U.S., nor have they suffered the from its devastating aftermath. There are a variety of reasons for this, many of which are explored in an excellent article on McClatchy today by Kevin Hall that discusses some of the policies that allowed Canada to survive the bubble relatively unscathed.

From the article:

“One in 4 U.S. homes is thought to be worth less that the mortgage being paid on it. One in every 492 U.S. homes received a foreclosure notice in November. For the fourth year running, analysts are speculating on where the bottom is for U.S. real estate. No such worries up here in Canada — yet its system of mortgage finance gets little attention in the U.S. Not a single Canadian bank failed during the Great Depression, and not a single one failed during the recent U.S. crisis now dubbed the Great Recession. Fewer than 1 percent of all Canadian mortgages are in arrears.”

Quite simply, Canada has not engaged in the subprime, no-doc, risky mortgage lending that many in the United States participated in. Canadian lending standards are far more conservative than in the United States, and banks are required to hold larger capital reserves in the event that loans go bad. In addition to this, Canada does not have a direct analogue to Fannie Mae or Freddie Mac (although they do have the Canada Mortgage and Housing Corporation, which insures hundreds of billions worth of mortgages and mortgage backed securties, so some risk is transferred to the government). While there is some criticism of the CMHC in some quarters, it doesn’t appear to have anywhere near the liability that Fannie or Freddie have.

Canada also doesn’t have fixed rates mortgages, nor is there a mortgage interest deduction. This means that borrowers have the incentive to pay off their mortgages as quickly as possible. Additionally, because mortgage rates are allowed to adjust to market conditions after 5 years, the interest rate risk falls upon the borrower rather than the lender. This helps to keep mortgage rates low. Patrick Lawler, Chief Economist for the Federal Reserve estimates that Americans pay 1/2-full point more in interest rates because the banks have to assume the interest rate risk.

Finally, Canada’s mortgages are recourse loans. This means that if a Canadian borrower defaults on their mortgage debt, they cannot give the house back to the bank and walk away from the debt, as Americans in many states can. Canadians are still responsible for whatever debt remains on their mortgage after the proceeds of a foreclosure sale are applied. This gives Canadian borrowers even more incentive to stay current on payments. Do you think the Canadian model would work in the United States? Let me know in the comments section below.

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16 Comments »

Nick
January 13, 2011 @ 7:29 pm

US home loans are recourse. It’s up to lenders to sue borrowers for post foreclosure deficiancies.

Michael Kraus Reply:
January 14th, 2011 at 8:59 am

This is true, 12 states are non-recourse states, 6 are one-action states, and the rest are recourse states. I should’ve made that more clear in the article.