5 Reasons Canada’s Housing Market Won’t Crash as the Market in the U.S. Did 10 Years Ago

The Canadian housing market may be on the verge of a correction, but here are five good reasons why the market and lender Home Capital Group Inc. (TSX:HCG) won’t suffer the same fate as the U.S. markets did 10 years ago.

| More on:
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn moresdf

Much has been made over the past decade of Canada’s rising household debt, which is now at levels similar to those in the United States prior to the 2008-09 Financial Crisis.

With housing prices in Toronto up more than 30% over the past 12 months, and Vancouver prices having been inflated for several years, many are wondering: now that the Bank of Canada has raised interest rates twice in the last three months, will it be enough to topple the Canadian housing market?

There are five very important reasons why investors should not expect a housing correction in the Canadian market to be of nearly the same magnitude as the one experienced in the United States 10 years ago.

Reason #1: The United States incentivizes home ownership

In the U.S., federal policy actively encourages home ownership, whereas in Canada, policies are designed to encourage access to housing, but they do not explicitly favour home ownership over renting or leasing a property.

It seems then only natural to suggest that creating incentives for home ownership (like, for example, allowing mortgage interest to be tax deductible in the U.S.) would be more likely to create an environment ripe for a housing bubble.

Reason #2: Canada’s housing market is directly backed by the Federal government

In the U.S., Fannie Mae and Freddie Mac are responsible for providing guarantees on mortgage-backed securities and providing overall stability to the housing system.

At the time of the Financial Crisis, Fannie Mae and Freddie Mac were privately owned, with the “implicit” backing of the Federal government. Yet, when push came to shove, investors learned the hard way the difference between an implicit guarantee and direct backing.

By comparison, the Canadian equivalent responsible for providing insurance and stability, is the Canada Mortgage and Housing Corporation (CMHC) — a Crown corporation directly owned by the Canadian Federal government.

Reason #3: Canada does not allow non-recourse mortgages

In Canada, mortgages are typically “full-recourse” loans, meaning the borrower continues to be responsible for repaying the loan in the event of a foreclosure, which effectively incentivizes the borrower to do everything in their power to avoid foreclosing and losing the property.

Meanwhile, many U.S. states employ “non-recourse” mortgages, which, in the event of a foreclosure, allow the borrower to walk away from their homes, leaving the lender with no-recourse besides taking over ownership of the property.

It’s easy to see how non-recourse mortgages can exacerbate the problem of homeowners defaulting on their payments.

Reason #4: Canada has tighter restrictions on mortgage insurance

Canadian legislation prohibits lenders from issuing mortgages without loan insurance if the loan is greater than 80% of the value of the property.

Insurance which is purchased from the CMHC covers the entire amount of the loan for the entire life of the mortgage.

In the U.S., it is a little different; while many lenders will require insurance, they are not legally obligated to do so.

Moreover, in the U.S., loan insurance is “partial,” often covering 20-30% of the loan amount and is cancelled as soon as the value of the loan falls below 78% of the purchase price.

Reason #5: The relative absence of a subprime market in Canada

Sub-prime mortgages are made to riskier borrowers, such as those with a weaker credit history or less stable income.

In the U.S., before the housing crisis, the sub-prime mortgage market peaked at 23.5% of all mortgage originations.

By contrast, in Canada today, the sub-prime mortgage market, which includes Home Capital Group Inc. (TSX:HCG), accounts for less than 5% of originations, making the market significantly less risky.

Conclusion

Regardless of how you look at it, rising interest rates are not a good omen for the future of Canada’s housing market. And while delinquencies today are well below historical averages, that may actually be confirming evidence that a bubble is present.

Current and prospective homeowners should approach the market with caution. Those warning that the “sky is falling” and that the environment is similar to the situation in the U.S. 10 years ago, ought to think a bit more Foolishly.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Jason Phillips owns shares in Home Capital Group Inc.

More on Dividend Stocks

growing plant shoots on stacked coins
Dividend Stocks

5 Dividend Stocks to Buy With Yields Upwards of 5%

These five companies all earn tonnes of cash flow, making them some of the best long-term dividend stocks you can…

Read more »

funds, money, nest egg
Dividend Stocks

TFSA Investors: 3 Stocks to Start Building an Influx of Passive Income

A TFSA is the ideal registered account for passive income, as it doesn't weigh down your tax bill, and any…

Read more »

A red umbrella stands higher than a crowd of black umbrellas.
Dividend Stocks

3 of the Safest Dividend Stocks in Canada

Royal Bank of Canada stock is one of the safest TSX dividend stocks to buy. So is CT REIT and…

Read more »

Growing plant shoots on coins
Dividend Stocks

1 of the Top Canadian Growth Stocks to Buy in February 2023

Many top Canadian growth stocks represent strong underlying businesses, healthy financials, and organic growth opportunities.

Read more »

stock research, analyze data
Dividend Stocks

Wherever the Market Goes, I’m Buying These 3 TSX Stocks

Here are three TSX stocks that could outperform irrespective of the market direction.

Read more »

woman data analyze
Dividend Stocks

1 Oversold Dividend Stock (Yielding 6.5%) to Buy This Month

Here's why SmartCentres REIT (TSX:SRU.UN) is one top dividend stock that long-term investors should consider in this current market.

Read more »

IMAGE OF A NOTEBOOK WITH TFSA WRITTEN ON IT
Dividend Stocks

Better TFSA Buy: Enbridge Stock or Bank of Nova Scotia

Enbridge and Bank of Nova Scotia offer high yields for TFSA investors seeking passive income. Is one stock now undervalued?

Read more »

Golden crown on a red velvet background
Dividend Stocks

2 Top Stocks Just Became Canadian Dividend Aristocrats

These two top Canadian Dividend Aristocrats stocks are reliable companies with impressive long-term growth potential.

Read more »