Subprime borrowers had a harder time converting to bank loans over the past decade

Subprime borrowers have had a harder time getting a loan from a bank over the past decade, as federal mortgage rules got tougher.

That is the finding from a new report from Canada Mortgage and Housing Corp that looks at the growth of alternative lenders such as mortgage investment entities and private lenders.

The report analyzes the alternative lenders and their borrowers’ ability to exit the high-interest loans.

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Alternative or subprime lenders offer more expensive, higher-interest, short-term loans to borrowers with weak credit. These borrowers are unable to qualify for a cheaper mortgage from a chartered bank and typically use the subprime loan as a stopgap measure to make their mortgage payments as they improve their creditworthiness.

Last year, 71.5 per cent of subprime borrowers in Ontario were able to get a mortgage from a bank or sell their property without defaulting on loan payments or losing their property to foreclosure. That is down from 83 per cent in 2011, according to a CMHC report released on Wednesday. The report relies on data from Teranet, Ontario’s electronic land registry system.

“This share has decreased significantly in the past decade,” said CMHC.

The difficulty stems from the federal government’s tougher bank mortgage stress test that was introduced in 2016 to ensure that borrowers could continue to make their monthly mortgage payments when interest rates started to increase.

The rule only applies to mortgages from chartered banks and requires borrowers to prove they can make their payments at an interest rate that is at least two percentage points higher than their actual contracted rate.

“The decrease in switches to conventional lenders during the last decade is in part due to a series of macroprudential regulations and tighter underwriting standards making it more difficult for borrowers to return into that space,” said CMHC.

While CMHC only has data to 2021, this trend is likely to continue with mortgage rates quickly climbing as the Bank of Canada raises interest rates to combat soaring inflation. The benchmark interest rate has risen 125 basis points in four months and is expected to increase further at the central bank’s next scheduled interest rate announcement next week.

The five year fixed mortgage is double the cost of last year and nearing an interest rate of 5 per cent. That means borrowers must prove they can make mortgage payments at an interest rate of nearly 7 per cent. That has made it harder for borrowers to qualify, especially borrowers that have faced credit problems.

The CMHC study found that subprime borrowers stayed with an alternative lender longer than anticipated. “Given the higher interest rates, this may pose long-term affordability issues for these borrowers,” said the study.

Over all, CMHC said alternative lenders account for 12 per cent of mortgage transactions in Ontario and are involved in up to 90 per cent of foreclosures in the province each year.

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