Alternative lenders gain ground at the expense of banks

The combined effect of the explosion in the key rate and the gradual tightening of mortgage rules in recent years has resulted in increasing the market shares of non-traditional, or so-called alternative, mortgage lenders, both in Quebec and elsewhere in Canada. .

This is one of the little-known consequences of the imposition by Ottawa, from 2018, of a new borrower qualification system, the famous stress test, observes the Canadian Mortgage and Housing Corporation (CMHC), the main organization responsible for housing in the country.

“As we see mortgage lending volume slow at traditional banks and credit unions, we see mortgage lending rapidly increase at non-traditional lenders. A relatively new situation that certainly raises all kinds of questions,” recognizes economist Tania Bourassa-Ochoa, senior specialist, Housing Research at CMHC.

Short terms and high rates

These Mortgage Investment Entities (MHPEs) are mortgage lenders offering loans that are characterized by short terms (6 to 24 months) and high interest rates. They include mortgage investment companies and other private lenders of all kinds.

Typically, these entities provide loans to borrowers who do not qualify with traditional lenders. Because unlike big banks, they are not regulated by the Office of the Superintendent of Financial Institutions (OSFI). They therefore do not have to subject their clients to the imposed rules of the stress test, also known as the resistance test.

While all mortgage lenders have experienced a slowdown in business due to rising prime rates in recent years, non-traditional lenders have experienced the least slowdown and have increased their market share.

According to CMHC, which is still refining its knowledge of this gray market, their overall market share remains marginal, at around 5%. It is quite different, however, for the market for “newly granted” mortgage loans.

In this specific segment, a harbinger of their future importance, their share stood at 19.5% in the first quarter of 2023, up 4.6 percentage points compared to 14.9% in 2021. In spring 2023 , assets under management of the 25 largest SPHs in Canada had increased by 7.1% year over year.

Attention danger

Economist Bourassa-Ochoa believes that these entities have their place in society and play an important role in liquidity by providing funds to people who immediately need money to avoid defaulting on their mortgage commitments.

“Using these lenders can be useful for one-off needs such as debt consolidation, loss of income due to illness or layoff. In such cases, a loan is primarily intended to facilitate their return to the world of traditional loans.

“The problem, the danger,” she continues, “is when a growing number of clients, as we seem to be seeing now, begin to resort to these private lenders with permanently high interest rates without ever being able to access or to return to the world of traditional loans.”

For the moment, more than 85% of the activities of these alternative lenders are concentrated in the territories of Ontario and British Columbia, where housing costs are, by far, the highest in the country.

Their presence, however, tends to grow rapidly elsewhere, and particularly in Quebec. In the third quarter of 2021, only 4.1% of alternative lenders’ activities took place in Quebec.

However, according to the latest available data, 18 months later, i.e. after the first quarter of 2023, the proportion of the business volume of these companies in the province had increased by 53% (or 2.2 percentage points) for stand at 6.3%.

The stress test for dummies:

For what?

Also known as the stress test, the latter was put in place to verify the ability of borrowers to repay their debts, in the event of a change in their life (separation, illness, loss of employment) with an impact on their income and expenses, or a significant increase in mortgage rates. Ottawa believes that it protects both borrowers against excessive debt and the Canadian financial system against borrower defaults.

Who is he talking to?

All new mortgage borrowers must comply, whether they make a minimum down payment of 5% or their down payment is greater than 20%. Homeowners who already have a mortgage must also comply if they wish to change lender, obtain a mortgage line of credit or refinance a property.

What does it consist on?

Before obtaining a mortgage loan, financial institutions must stress test each borrower’s credit file. The latter consists of submitting the loan application at the highest rate between the minimum admissible rate of 5.25%, decreed by the Office of the Superintendent of Financial Institutions (OSFI), and the rate granted by the lending institution increased by 2 percentage points.

The result?

Ultimately, the borrower’s gross debt ratio related to housing must be less than 39% and the overall debt ratio (comprising all debts, including housing debt) must be less than 44 %. If the test fails, the requested loan will be refused.