If you ask the folks over at The National Post, they would seem to suggest, “yes.”
An article ran in the Financial Post last week about “Joe Schmo” lenders that I personally felt was a little misleading, since they were talking about the “dangerous” lenders while interviewing people from alternative, albeit “A-lenders” like Street Capital, First National, and MCAP. The latter three are A-lenders, who basically use the same lending criteria as the Big-5 banks; they just don’t have old-lady chequing accounts and security deposit boxes, like the Big-5 banks.
So should we be worried about “Joe Schmo lenders doubling their stake in Canada’s mortgage market,” as the Financial Post article suggests? Or should we be happy that there are options outside of the banking oligopoly?
I am not an expert on this subject.
I do have my opinions on the matter, but as soon as I began discussing this with my mortgage broker, Joe Sammut, I realized I needed him to write this blog, not me.
So I asked Joe very simply, “What do you think about the article?”
He didn’t agree with the content, on the whole, but also the way it was written.
I asked Joe for a “response” to the article, but then just because I know how people think, I proposed five questions to stimulate the conversation that would undoubtedly ensue.
So first, here’s Joe’s response to the Financial Post article:
Has Joe Schmo Begun the Wild West in the Field of Secured Lending?
The Financial Post featured an article last Wednesday discussing “Joe Schmo” lenders and the risk they pose to the market. The absence of federal and provincial regulation would, undoubtedly, allow private and alternative lenders to go rogue and gouge clients wherever possible and it’s a scary thought. But what is meant by a “Joe Schmo” lender and how much freedom do these people/institutions have to lend? How much regulation is there prohibiting them from engaging in – for lack of a better word – predatory lending?
We’ll start with the non-traditional bank lenders; institutional lenders that are not the big five banks. In the industry we call them mono-line lenders because they only have the one line, being their mortgage products. The article alludes to a few being First National, Street Capital Group, and MCAP. While there are roughly 35-50 others depending on what province you operate in, we can use these three as perfect examples of mono-line lending and regulation. As it turns out, these three lenders are all considered “A” lenders. They only lend on “A” business meaning the borrower needs decent enough credit, reasonable income to service the mortgage, and low debt levels. They (mono-line lenders) do have programs that think outside the box such as stating incomes for self-employed individuals whose taxable incomes don’t reflect their actual lifestyles for example, but these programs are often niche products and don’t represent the large portion of business that goes to these lenders. This is especially true in my brokerage as we regard most mono-line lenders as “A” business only. One might say that these lenders have similar if not exactly the same risk tolerance as the big five banks when it comes to mortgage lending. But of course, reading that they have books of nearly $200 billion combined can make things seem very scary. The fact is, these lenders which make up a very large portion of the mortgage market are being just as conservative as the big five banks.
So what happens if a client can’t get approved through a bank or a mono-line lender? In that case, there are “B” lenders or what we call “Alt-A” lenders. These lenders typically have a larger appetite for risk and will lend to clients with bruised credit, non-traditional sources of income, or not enough established credit in Canada. With these risks comes higher interest rates. While “A” lenders currently charge around 2.5% for a 5yr term, “B” lenders will typically charge anywhere around 4-7% for a 1yr or 2yr term. The reason for shorter terms is twofold. One, it mitigates the risk taken on by the bank as less time on the loan means less exposure to any market volatility; and two, this type of lending is never seen as a permanent solution, but instead, a temporary solution until we can make the client more appealing to “A” lenders again. It’s worth noting here that this is how any mortgage broker/agent worth their salt should approach “B” lending but this isn’t always the case. The sour apple spoils the bunch unfortunately…
Now, what if a client still carries too much risk for a “B” lender to approve them? That is when a mortgage broker would turn to private lending or in some cases, alternative lending sources. These funds are oftentimes costly and should only ever be used as a temporary solution until the client can either improve their situation or offload the property. Rates in this instance can range anywhere from 7-25% depending on the client’s credit, debt, income, location of their property, etc. Because these lenders are less regulated, there is no saying what a lender might want to charge a client. Having said that, good ol’ fashioned supply and demand still plays a role here. Although one alternative lender may want to charge you 21.1%, another may be willing to lend at 18.5% and another at 12.75%. This competition in the private/alternative market usually brings the pricing down to a fair market rate that is reasonable given the risk of the client.
All of the above are options available to a client assuming their mortgage broker/agent/representative is working in their best interest. But as with any industry, that isn’t always the case. Unfortunately, we’ve seen clients offered rates 5-10% higher than should be expected with fancy mathemagic that makes it next to impossible to calculate exactly how much interest the client would be paying. By law, a lender cannot charge more than 60% APR (Annual Percentage Rate) including all compounding, fees, etc. Anything more than this is considered usury but anything less is fair game in the eyes of the regulators. When your local jewellery buyer or pawn shop offers home loans fast and easy with little documentation, their 18.5% rate compounded monthly plus lending fees, etc. can quickly start to approach that line. This is the type of predatory lending that leaves consumers over-leveraged and threatens the healthy operation of the economy. But are these the guys “doubling the stake in Canada’s mortgage market”?
Now here are my “five questions” and Joe’s answers:
1) What do you say to the somewhat-informed, and/or article “skimmer,” and/or anonymous internet commenter, who offers the generalization, “If you can’t get financing from a Big-5 bank, you shouldn’t get financing, otherwise these alternative lenders are simply allowing non-qualified buyers into the market, and thus artificially propping up the real estate market, and heading us towards a U.S.-style real estate collapse, circa 2008 with their shoddy lending practices?”
I would re-word this question as “What do you say to the skeptic who offers the typical adage “If you can’t get financing from a Big-5, you shouldn’t be getting financing at all. Otherwise These alternative lenders are helping to artificially prop up this crazy real estate market. Aren’t we setting ourselves up similar to the US before the 2008 housing collapse?”
I would say that the fear of a housing collapse is a completely legitimate fear, but the chances of this causing a housing collapse are very slim and any sensationalist media is somewhat misinformed. In our day to day operations, we see perfectly stable clients turned down with the Big-5 because they are tightening their reins. These are not credit-seeking, debt-reliant clients who are irresponsible with money; they are typically clients that can easily afford to service the mortgage but have either non-traditional forms of income (self-employment, commission, overtime hours, international income, etc) or a very reasonable explanation for bruised credit. These clients are put into reasonably priced alternative mortgages as a temporary solution until their situation can be improved. If the risk is too great, however, they don’t even qualify for these loans and instead need to turn to higher risk-tolerant lending such as private funds, MICs (Mortgage Investment Corporations), or smaller alternative lending institutions. It’s worth noting that these types of lending solutions are almost always used to refinance out of bad situations and very, very rarely used as a means of purchasing (and thus falsely propping up the market).
In other words, there are very healthy reasons for a client to seek alternative financing and with the right advisor, it’s a quick and temporary fix. Alternative financing should almost never be used as a means of acquiring real estate if there is no intention of ever qualifying as an “A” client.
2) What is the difference between “Big-5 Banks” and First National, Street Capital, and MCAP?
In terms of overall services, mono-line lenders like First National, Street Capital, MCAP, and many other lenders offer only mortgage products. They don’t typically deal in student loans, saving accounts, unsecured lines of credit, or other banking services. Otherwise, their mortgage products are on par with each other. Most mono-line lenders have mortgage products with similar rates, features, and benefits.
3) If a buyer cannot obtain financing through a Big-5 Bank, are we to simply assume that they can obtain financing through an Alternative-lender, and if so, how would that look?
If a buyer cannot obtain financing through a Big-5 bank, we can oftentimes still obtain an “A” mortgage through a mono-line lender. A decline from a Big-5 bank can sometimes be as simple as the client not having enough of a banking relationship established or having an income that doesn’t quite fit the bank’s “box”.
If, however, the client truly isn’t an “A” client, we would then turn to “B” financing which has somewhat more lax underwriting guidelines and higher rates/fees. This jump from “A” to “B” rates isn’t gigantic but is often significant enough to make unwise decisions like overspending or over-leveraging cost-prohibitive.
4) Two buyers have a $250,000 down payment on an $800,000 house, but they are self-employed, show little income, and thus the Big-5 banks will not provide financing. How is this deal structured with an Alternative lender?
Contrary to what some might think, these buyers could potentially still qualify for a mortgage with a mono-line lender. The mortgage would still have the same rate, features, and benefits that a bank would offer as well. Sometimes the difference is as simple as a deal making sense but not fitting a cookie cutter mold that most of the Big-5 have.
5) A buyer has a 5% down payment on a $400,000 condo, but shows no income, no credit, and thus the Big-5 banks will not provide financing. How is this deal structured with an Alternative lender?
In this case, this is a fairly high-risk deal. Very few institutions (“A”, “B”, or otherwise) would entertain this transaction which would only leave two viable options. The client would either need to obtain private financing or rely on a “No Questions Asked” lender such as a pawn broker or jewelry store owner. In either case, the risk is so high that I would imagine rates would exceed 30%. It’s difficult to say how high the rate would be as these cases are so rare and are almost intentionally priced to deter this type of behaviour.
Now let me ask you:
Do you think there’s a benefit to opening the lending industry to those outside the Big-5 banks?
Or are you willing to blow this entire conversation out of proportion, and start talking about a U.S.-style housing crisis as a result?
Maybe there’s an opinion somewhere in between, so have your say below…