The largest difference between Canada’s housing market and the U.S. is that Canadian mortgages are full recourse. In Canada, if you take out a mortgage and then default when it is ‘underwater’ – your home value is less than our mortgage – your other assets and future income are at risk. In the U.S., only select states have any sort of recourse at all, and even then it tends to be loosely applied.
Although American mortgage defaulters face years of rebuilding credit, they never have to make up for negative equity. Thus during the worst of the mortgage crisis, many Americans simply walked away and continue to do so. An Experian-Wyman study estimated that as many as 20 per cent of foreclosures were strategic defaults. Homeowners who could make payments, but simply decided to stop. I suspect that strategic defaults are more common in the U.S. now. Since the study was completed, a number of people have come out advocating the practice. In fact, a number of books are available to help homeowners strategically default. CBS 60 Minutes did a special on the practice and estimated that 1 milllion U.S. homeowners strategically defaulted, twice the number estimated in 2009.
Unsurprisingly, U.S. housing prices keep falling and homeowners keep foreclosing. Strategic defaults create a snowball effect. As more and more people strategically default, foreclosed homes flood the market further, incentivizing more people to strategically default.
This is simply not a good option for Canadian mortgage holders. Canadian homeowners buy homes with the knowledge that their other assets and future wages could be on the line if their home value is underwater. Even in 2009 when the Canadian economy was in recession and housing prices fell 9 per cent, the percent of Canadian mortgages in arrears rose, but not by much.
Even during the last major price correction that began in 1989 in Toronto, the number of mortgages in arrears 90 days or more didn’t even hit 1 per cent. In the U.S. 90-day arrears hit an incredible 4.7 per cent at the end of 2009. Furthermore, a wild appreciation rate of over 20 per cent per year in Toronto (which makes up about 40% of Canada’s housing market) for several years preceded the crash.
History shows that Canada is not immune to a housing price correction, but the inability of Canadians to simply walk away from a mortgage contains the steepest to the most overheated markets. For Canada’s banks, full recourse mortgages mean that they are a far safer investment – the risk of selling a foreclosed home below the mortgage value is substantially lower and there is little risk of a financial contagion like that which affected the U.S. and global markets.