Rocketing interest rates, a spiralling cost of living, larger-than-ever mortgages and rising unemployment are a bad combination for creditors.
It’s largely why consumer insolvencies are surging. About 100,000 more consumers missed a credit payment last quarter, compared with a year ago, reports Equifax. And the total number of consumer insolvencies in August jumped 27.6 per cent over the same month a year ago.
The closer we get to recession, the faster insolvencies will climb. Add plunging home values to the mix and you’ve got a recipe for mortgage defaults. Few expect a catastrophic increase, but a threefold to fivefold increase in the current 0.14 per cent 90-day arrears rate is certainly possible.
We’re already seeing a small minority of homebuyers underwater on their mortgages – owing more to their lender than their home is worth. That boosts the probability of default materially.
For negative-equity homeowners who can no longer make their mortgage payments and have tried all other options – it often leaves a fundamental question: File for bankruptcy or file a consumer proposal?
A tough decision
For those who know they’re going to miss a mortgage payment, the first and only sensible step is to proactively contact the lender or default insurer – if the mortgage is insured.
If it’s a mainstream lender and you’ve never missed a payment before, they won’t kick you out of your house. Instead, they’ll try to work with you for as long as possible, to help you get current on your mortgage.
For mortgagors who’ve exhausted all deferral and workout options offered by their lender or insurer, bankruptcy or a consumer proposal is often the only way out. But which one?
For those with little to no equity after selling costs, bankruptcy costs less to file but your credit pays the worst price, says Scott Terrio, manager of consumer insolvency at Hoyes, Michalos &. Associates.
“In a consumer proposal, you get a gentler R7 rating, but it costs more.” The difference in ratings matters, he says, because “you never have to answer ‘yes’ to the eventual future credit or job application question ‘Have you ever filed for bankruptcy?’ ” (R7 is a credit bureau code that tells lenders you are making a consolidated debt payment.)
If there’s ample equity and a desire to keep the home then a proposal usually makes more sense. The reason is simple. “In a bankruptcy, home equity triggers the trustee selling the home to distribute the assets (the net equity) to creditors,” Mr. Terrio says.
If one’s home equity exceeds the unsecured debt, which is often the case, a consumer proposal would require repayment of 100 per cent of the unsecured debt.
For example, if the homeowner had equity of $100,000 but unsecured debts of $30,000, they’d have to pay back that full $30,000 over five years ($500 a month) to their creditors. But then they could keep their home.
If you’re a mortgagor who’s tapped all available options from your lender, and you still can’t pay your bills, get a free consultation from a reputable licensed insolvency trustee immediately. The sooner you act, the sooner you’ll eliminate your debt stress –and potentially save your home.
Rental financing
In the real estate heydays – which were about seven months ago – it was common to see income property investors borrowing against their rental properties to buy more rental properties. It was leverage upon leverage – which is fine if you’re well qualified and know what you’re doing.
Problem is, some undercapitalized borrowers took it too far, levering themselves to the limit.
They’d typically refinance up to the maximum 80 per cent loan-to-value, pull out equity and use as a down payment on a new income property, focusing too much on potential price appreciation and too little on net rental income potential.
In the months to come, we’re going to hear more about such folks. Namely, we’ll hear anecdotes about how their rental income didn’t cover their expenses, forcing them to sell their properties.
Unfortunately, home values will have fallen so much – in some markets – that even selling won’t bail them out. That is, generate enough sale proceeds, after selling costs, to pay off their mortgage lender(s).
That’s why smart investors play it conservative.
Take Scott McGillivray, host of HGTV’s Income Property, for example. He owns hundreds of rental properties and his golden rule is simple.
“Try to maintain 40-per-cent equity,” he says. That way, debt service costs are manageable, which means your cash flow is more likely to be positive. And, if you do have to sell, there’s plenty of equity to absorb big corrections in home values.
Is now really the time to invest?
Just because interest rates are high, that’s no reason to avoid income property investing – not if you’re financially secure, can hold long-term and come across a bargain.
Positive cash flow with 5.5-per-cent mortgage rates is still “100 per cent possible,” Mr. McGillivray says. Why? “Because mortgage rates and purchase prices typically go in opposite directions.”
“Paying 20 per cent more six months ago at a 2-per-cent rate is the same as paying 20 per cent less at an interest rate that’s two points more,” he says. From a cash flow standpoint, “The math at the end hasn’t change significantly.”
In fact, with surging rents, “cash flow in the next five years should be better than it’s been,” he adds. That’s even more true if recession drives rates lower in 18 to 24 months, allowing landlords to refinance out of today’s high rates.
Just be sure to pick a lender and term that minimizes your risk of mortgage prepayment penalties. That means a short-term fixed, variable, open mortgage or home equity line of credit. Mr. McGillivray says his term of choice is the three-year variable, largely for this reason.
Rates under pressure
With the U.S. Federal Reserve hinting at significantly higher interest rates, Canadian mortgage funding costs have jumped in sympathy.
The rate types most affected include:
Shorter fixed terms: Some of the best one- and two-year fixed rates have shot up 15 to 25 basis points or more in the past week. A lot of borrowers have gravitated to these terms on the belief that rates will drop in 2023 or 2024. Among national lenders, Alterna Bank remains the leader on these terms at 4.69 per cent.
Default insured mortgages: Insured rates tend to follow bond yields more quickly. As a result, numerous lenders have taken insured rates higher this week. That said, you can still find insured five-year fixed deals at 4.34 per cent or lower on online rate sites.
Rates in the accompanying table are as of Thursday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.
