Introduction to the Canadian Mortgage Industry PDF

Introduction to the Canadian Mortgage Industry sixth EDitiON authored By Mortgage Professionals Canada MortgageProsCan.ca 2005 sheppard avenue east, suite 401 toronto, Ontario M2J 5B4 Phone: 416-385-2333 Fax: 416-385-1177 While all information provided for this course text was from what we believe to be Disclaimer reliable sources, The content the program of this material cannot be guaranteed is not intended to be annorauthoritative does it purport to treat each reference subject concerning exhaustively. this course any Act, Rules text is, as The or Regulations. titled, Ontario final Mortgage authority agent in relation toLicensing the rules and course Participant interpretation Manual of the rules and is intended governing mortgageto meet the learning brokerage, broker,objectives agent andasadministrator identified in the introductory businesses pages. canada’s that an individual or entitymortgage industry is required is governed to comply with areby enforced both federalby and provincial the relevant legislation. provincialthese materials or federal are notbody. regulatory intended to regard, In this be a comprehensive it is the reader’ review s soleof such legislation and, therefore, the reader should make appropriate responsibility to ensure compliance with any Act, Rules and Regulations, and to retain inquiries to determine the legislation competent applicable legal or otherto a particularcounsel professional situation.as no maypart of this document be required from timemay be used, to time to adapted, translated, advice. obtain professional reproduced, stored Mortgage in a retrievalCanada Professionals system,(and/or or transmitted, in any form its employees) does or by notany means, accept andwithout the prior specifically written disclaims anypermission of Mortgage responsibility of liabilityProfessionals whatsoevercanada.arising from the use or reliance by the reader upon any portion of the contents of this email, or for any consequential losses, damages, penalties or fines that might result. No part of this document may be used, adapted, translated, reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior written permission of Mortgage Professionals Canada. © January, 2024 Mortgage Professionals canada. all rights reserved. isBn: 978-0-9780718-6-8 TABLE OF CONTENTS MODULE ONE OVERVIEW OF THE INDUSTRY.................................................... 3 1.1 LEARNING OBJECTIVES............................................................................ 3 1.2 INTRODUCTION........................................................................................ 3 1.3 HISTORY OF THE MORTGAGE INDUSTRY.............................................. 3 1.3.1 LEGAL HISTORY........................................................................... 4 1.3.2 FINANCIAL HISTORY................................................................... 6 1.4 MARKET SIZE AND TRENDS................................................................... 14 1.4.1 MORTGAGE TRENDS – MORTGAGE SURVEY......................... 18 1.5 UNDERSTANDING REAL ESTATE AND MORTGAGE FUNDING........... 20 1.5.1 THE FACTORS AFFECTING REAL ESTATE................................ 20 1.5.1.1 DEMAND.................................................................... 21 1.5.1.2 SUPPLY........................................................................ 24 1.5.2 MORTGAGE FUNDING SOURCES............................................25 1.5.2.1 FINANCIAL INSTITUTIONS........................................25 1.5.2.2 MORTGAGE-BACKED SECURITIES............................ 29 1.5.2.3 GOVERNMENT LOANS.............................................. 31 1.5.2.4 PRIVATE LENDERS...................................................... 32 1.5.2.5 ALTERNATIVE LENDING............................................33 1.6 KEY PARTICIPANT ROLES AND RESPONSIBILITIES..............................34 1.6.1 MORTGAGE ORIGINATOR........................................................34 1.6.2 LENDER..................................................................................... 35 1.6.3 BORROWER............................................................................... 35 1.6.4 REAL ESTATE AGENT................................................................. 35 1.6.5 PROPERTY/MECHANICAL INSPECTOR....................................36 1.6.6 REAL ESTATE APPRAISER..........................................................36 1.6.7 LAWYER......................................................................................36 1.6.8 MORTGAGE INSURER...............................................................36 1.6.9 TITLE INSURER........................................................................... 37 1.6.10 MORTGAGE SERVICER OR ADMINISTRATOR......................... 37 1.7 CHAPTER REVIEW................................................................................... 37 SUMMARY................................................................................................ 37 KEY TERMS.......................................................................................................... 39 APPLICATION EXERCISES...................................................................................40 Table of Contents iii MODULE TWO REGULATORY FRAMEWORK..................................................... 43 2.1 LEARNING OBJECTIVES..........................................................................43 2.2 INTRODUCTION......................................................................................43 2.3 REGULATION OF MORTGAGE BROKERS..............................................43 2.3.1 HARMONIZATION..................................................................... 49 2.4 REGULATION OF MORTGAGE LENDERS..............................................50 2.4.1 BANKS........................................................................................50 2.4.2 SAGENTM AND CANADA GUARANTY....................................... 52 2.4.3 TRUST COMPANIES AND MORTAGE LOAN COMPANIES...... 52 2.4.4 THE OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS (OSFI)................................................................ 52 2.4.5 OTHER LENDERS....................................................................... 53 2.5 REGULATION OF MORTGAGE INSURERS.............................................54 2.5.1 CANADA MORTGAGE AND HOUSING CORPORATION (CMHC).......................................................................................54 2.5.2 SAGEN™ AND CANADA GUARANTY....................................... 55 2.6 THE ROLE OF MORTGAGE PROFESSIONALS CANADA....................... 55 2.7 THE ROLE OF NON-REGULATORY INDUSTRY ORGANIZATIONS.......56 2.8 CHAPTER REVIEW................................................................................... 59 SUMMARY................................................................................................ 59 KEY TERMS..........................................................................................................60 APPLICATION EXERCISES................................................................................... 61 iv Introduction to the Canadian Mortgage Industry, Sixth Edition MODULE THREE LEGAL OVERVIEW...................................................................... 63 3.1 LEARNING OBJECTIVES..........................................................................63 3.2 INTRODUCTION......................................................................................63 3.3 BASIC CONTRACT LAW..........................................................................63 3.3.1 ESSENTIAL ELEMENTS OF A CONTRACT................................64 3.3.1.1 OFFER.........................................................................64 3.3.1.2 ACCEPTANCE.............................................................. 67 3.3.1.3 CONSIDERATION.......................................................68 3.3.1.4 LEGAL INTENT........................................................... 69 3.3.1.5 CAPACITY (OR INCAPACITY)..................................... 70 3.3.1.6 LEGAL OBJECT (OR LEGALITY).................................72 3.3.1.7 GENUINE CONSENT..................................................72 3.3.2 VOID, ILLEGAL, VOIDABLE AND UNENFORCEABLE CONTRACTS.............................................................................. 76 3.3.3 TERMINATION OF A CONTRACT..............................................77 3.3.3.1 PERFORMANCE.........................................................77 3.3.3.2 AGREEMENT TO WAIVE PERFORMANCE.................77 3.3.3.3 NON-FULFILLMENT OF A CONDITION PRECEDENT................................................................77 3.3.3.4 FRUSTRATION............................................................ 78 3.3.3.5 BREACH OF CONTRACT............................................ 79 3.3.3.6 ASSIGNMENT.............................................................80 3.3.3.7 DOCTRINE OF PRIVITY..............................................82 3.3.4 REMEDIES..................................................................................83 3.3.4.1 DAMAGES...................................................................83 3.3.4.2 SPECIFIC PERFORMANCE..........................................84 3.3.4.3 INJUNCTION...............................................................84 3.3.4.4 QUANTUM MERUIT............................................ 84 3.4 REAL ESTATE OWNERSHIP..................................................................... 85 3.4.1 PROPERTY AND OWNERSHIP..................................................86 3.4.1.1 OWNERSHIP.............................................................. 87 3.4.1.2 RIGHTS IN LAND LESS THAN OWNERSHIP.............89 3.4.1.3 LAND TITLE AND REGISTRATION............................90 3.4.2 CO-OWNERSHIP OF INTERESTS IN LAND..............................90 3.4.2.1 JOINT TENANCY......................................................... 91 3.4.2.2 TENANCY IN COMMON............................................ 91 Table of Contents v 3.5 REAL ESTATE AND MORTGAGE CONTRACTS...................................... 92 3.5.1 REAL ESTATE DOCUMENTATION............................................. 92 3.5.1.1 THE LISTING AGREEMENT........................................ 92 3.5.1.2 AGREEMENT OF PURCHASE AND SALE.................. 93 3.5.1.3 TRANSFER/DEED OF LAND...................................... 93 3.5.2 MORTGAGE DOCUMENTATION............................................... 93 3.5.2.1 BORROWER COVENANTS.........................................94 3.5.2.2 MORTGAGE LENDER COVENANTS.......................... 95 3.5.2.3 MORTGAGE / HYPOTHEC.........................................96 3.5.2.4 DISCHARGE...............................................................96 3.5.3 MORTGAGE ENFORCEMENT....................................................96 3.5.3.1 FORECLOSURE........................................................... 97 3.5.3.2 POWER OF SALE........................................................98 3.5.3.3 OTHER REMEDIES......................................................99 3.6 CHAPTER REVIEW..................................................................................... 101 SUMMARY.............................................................................................. 101 KEY TERMS........................................................................................................ 102 APPLICATION EXERCISES.................................................................................104 MODULE FOUR MORTGAGE MATHEMATICS................................................... 109 4.1 LEARNING OBJECTIVES........................................................................ 109 4.2 INTRODUCTION.................................................................................... 109 4.2.1 THE TIME VALUE OF MONEY................................................. 109 4.3 SIMPLE INTEREST.................................................................................. 110 4.3.1 SIMPLE INTEREST EXPLAINED............................................... 110 4.4 COMPOUND INTEREST........................................................................ 113 WITH ANNUAL COMPOUND INTEREST:............................................. 114 4.4.1 COMPOUND INTEREST OVER TIME...................................... 115 4.4.2 COMPOUNDING PERIODS..................................................... 117 4.4.3 CALCULATING COMPOUND INTEREST................................. 119 4.5 EFFECTIVE INTEREST RATE A.K.A. ANNUALIZED PERCENTAGE RATE (APR)............................................ 122 4.5.1 EQUIVALENT INTEREST RATES.............................................. 124 vi Introduction to the Canadian Mortgage Industry, Sixth Edition 4.6 MORTGAGE PAYMENTS....................................................................... 125 4.6.1 THE INTEREST ACT.................................................................. 128 4.6.2 CHANGING PAYMENT SCHEDULES....................................... 130 4.6.2.1 CHANGING THE AMORTIZATION PERIOD............ 131 4.6.2.2 CHANGING THE PAYMENT FREQUENCY............... 132 4.6.2.3 CHANGING THE INTEREST RATE........................... 135 4.6.3 MORTGAGE AVERAGING........................................................ 135 4.6.4 TAXES AND MORTGAGES....................................................... 138 4.6.5 WHAT IS BEST FOR THE CLIENT............................................ 139 4.7 CHAPTER REVIEW.................................................................................140 SUMMARY..............................................................................................140 KEY TERMS........................................................................................................ 141 APPLICATION EXERCISES................................................................................. 142 MODULE FIVE UNDERSTANDING THE MORTGAGE PROCESS...................... 147 5.1 LEARNING OBJECTIVES........................................................................ 147 5.2 INTRODUCTION.................................................................................... 147 5.3 THE FIVE STEPS IN THE MORTGAGE APPLICATION PROCESS......... 147 5.3.1 MEETING WITH THE CLIENT.................................................. 149 5.3.2 MAINTAINING A LOAN FILE................................................... 152 5.3.3 EVALUATION OF THE SECURITY AND THE BORROWER..... 153 5.3.3.1 ANALYZING THE BORROWER................................. 153 5.3.3.2 ANALYZING THE PROPERTY................................... 155 5.3.4 ASSEMBLING THE DOCUMENTATION AND PRESENTING TO LENDERS..................................................... 156 5.3.5 NEGOTIATION AND COMMITMENT...................................... 157 5.3.6 LIAISON DURING THE CLOSING PROCESS........................... 157 5.3.7 ONGOING MORTGAGE ADMINISTRATION OR SERVICING.158 5.4 FINDING THE CLIENT/BORROWER...................................................... 158 5.5 CHAPTER REVIEW................................................................................. 160 SUMMARY.............................................................................................. 160 KEY TERMS........................................................................................................ 161 APPLICATION EXERCISES................................................................................. 161 Table of Contents vii MODULE SIX COMPLETING THE MORTGAGE APPLICATION...................... 163 6.1 LEARNING OBJECTIVES........................................................................ 163 6.2 INTRODUCTION.................................................................................... 163 6.3 COMPLETING THE MORTAGE APPLICATION..................................... 163 6.3.1 THE MORTAGE APPLICATION FORM..................................... 169 6.3.2 VERIFICATION OF THE APPLICATION.................................... 172 6.3.3 EMPLOYMENT AND INCOME VERIFICATION........................ 173 6.3.4 COPY OF THE AGREEMENT OF PURCHASE AND SALE........ 173 6.3.5 COPY OF THE PROPERTY LISTING......................................... 174 6.3.6 MORTGAGE INSURANCE INFORMATION............................ 174 6.3.7 COPY OF THE APPRAISAL....................................................... 174 6.3.8 CONFIRMATION OF DOWN PAYMENT.................................. 175 6.3.9 DOCUMENTATION FOR SWITCHING A MORTGAGE TO A NEW LENDER........................................................................... 176 6.3.10 DOCUMENTATION FOR REFINANCING A MORTGAGE........ 176 6.3.11 NOTES/EXPLANATION............................................................ 177 6.3.12 OTHER ITEMS THAT MAY BE REQUIRED.............................. 177 6.3.13 THE NEXT STEPS..................................................................... 178 6.3.14 TEN PRACTICAL RECOMMENDATIONS FOR A COMPLETE MORTGAGE TRANSACTION.................................................. 179 6.4 WHAT CAN MORTGAGE ORIGINATORS DO TO ASSIST LENDERS?.180 6.4.1 MOST COMMON ITEM MISSED IN A LOAN SUBMISSION.180 6.4.2 OTHER LENDER CONCERNS................................................... 180 6.4.3 OTHER SURVEY FINDINGS..................................................... 181 6.5 CHAPTER REVIEW...................................................................................... 182 SUMMARY.............................................................................................. 182 KEY TERMS........................................................................................................ 183 APPLICATION EXERCISES.................................................................................184 viii Introduction to the Canadian Mortgage Industry, Sixth Edition MODULE SEVEN QUALIFYING THE BORROWER............................................... 185 7.1 LEARNING OBJECTIVES........................................................................ 185 7.2 INTRODUCTION.................................................................................... 185 7.3 THE FIVE CS OF CREDIT........................................................................ 186 7.4 INCOME ANALYSIS AND VERIFICATION............................................. 187 7.4.1 TYPES OF ELIGIBLE INCOME.................................................. 188 7.4.2 TYPES OF INELIGIBLE INCOME.............................................. 188 7.4.3 INCOME VERIFICATION.......................................................... 189 7.4.3.1 FOR SALARIED INDIVIDUALS................................. 189 7.4.3.2 FOR SELF-EMPLOYED INDIVIDUALS...................... 190 7.4.3.3 FOR OTHER COMMON FORMS OF EMPLOYMENT INCOME.......................................... 192 7.5 THE FORMS OF BUSINESS OWNERSHIP............................................. 196 7.5.1. SOLE PROPRIETORSHIP.......................................................... 196 7.5.2 PARTNERSHIPS........................................................................ 197 7.5.3 CORPORATIONS...................................................................... 198 7.5.4 OTHER FORMS OF BUSINESS OWNERSHIP.......................... 199 7.6 UNDERSTANDING FINANCIAL STATEMENTS.....................................200 7.6.1 BALANCE SHEET.....................................................................201 7.6.1.1 ASSETS......................................................................201 7.6.1.2 LIABILITIES...............................................................202 7.6.1.3 SHAREHOLDERS’ EQUITY.......................................203 7.6.2 INCOME STATEMENT..............................................................203 7.6.3 STATEMENT OF RETAINED EARNINGS..................................204 7.6.4 STATEMENT OF CHANGES IN FINANCIAL POSITION (SCFP).......................................................................................204 7.6.5 NOTES TO FINANCIAL STATEMENTS....................................205 7.6.6 ANALYZING FINANCIAL STATEMENTS..................................205 7.6.6.1 PROFITABILITY RATIOS...........................................206 7.6.6.2 SHORT-TERM FINANCIAL RATIOS..........................206 7.6.6.3 LONG-TERM DEBT RATIOS.....................................206 7.6.6.4 SUMMARIZING THE COMPANY..............................207 Table of Contents ix 7.7 CREDIT REPORTS AND ANALYSIS........................................................207 7.7.1 REVIEWING A CREDIT REPORT..............................................208 7.7.3 UNDERSTANDING CREDIT RATINGS..................................... 211 7.7.4 UNDERSTANDING THE CREDIT SCORE................................. 213 7.7.5 BUSINESS CREDIT REPORTS................................................. 216 7.8 MORTGAGE RATIO ANALYSIS.............................................................. 216 7.8.1 DEBT SERVICE RATIOS............................................................ 217 7.8.1.1 GROSS DEBT SERVICE RATIO (GDS)....................... 217 7.8.1.2 TOTAL DEBT SERVICE RATIO (TDS)........................ 219 7.8.2 LOAN-TO-VALUE RATIO (LTV)................................................221 7.9 CHAPTER REVIEW.................................................................................223 SUMMARY..............................................................................................223 KEY TERMS........................................................................................................226 APPLICATION EXERCISES.................................................................................227 MODULE EIGHT MORTGAGE PRODUCTS, RELATED PRODUCTS, AND SUBMITTING THE APPLICATION.............................. 229 8.1 LEARNING OBJECTIVES........................................................................229 8.2 INTRODUCTION....................................................................................229 8.3 MORTGAGE PRODUCTS.......................................................................230 8.3.1 CONVENTIONAL VS HIGH RATIO MORTGAGES...................230 8.3.2 CLOSED VS OPEN MORTGAGES............................................231 8.3.3 FIXED VS VARIABLE RATE MORTGAGES...............................232 8.3.4 SPECIAL FEATURES.................................................................233 8.3.5 PRE-APPROVED AND PRE-QUALIFIED MORTGAGES...........235 8.4 MORTGAGE REPAYMENT PLANS.........................................................236 8.4.1 BLENDED PAYMENT LOANS...................................................236 8.4.2 INTEREST ACCRUING LOANS.................................................237 8.4.3 INTEREST ONLY LOANS..........................................................238 8.4.4 INTEREST PLUS SPECIFIED PRINCIPAL LOANS (STRAIGHT-LINE PRINCIPAL REDUCTION LOANS)...............238 8.5 TYPES OF MORTGAGE TRANSACTIONS.............................................240 8.5.1 PURCHASE, REFINANCE, EQUITY TAKE OUT, BLEND AND EXTEND, RENEWAL, AND SWITCH...............................240 8.5.2 RESIDENTIAL VS COMMERCIAL.............................................242 x Introduction to the Canadian Mortgage Industry, Sixth Edition 8.5.3 FIRST MORTGAGES VS SECOND MORTGAGES....................245 8.5.4 OTHER TYPES OF MORTGAGES.............................................247 8.6 SUBMITTING THE MORTGAGE APPLICATION...................................249 8.6.1 ELECTRONIC MORTGAGE DELIVERY SYSTEMS....................250 8.6.1.1 FILOGIX EXPERT......................................................250 8.6.1.2 NEWTON CONNECTIVITY SYSTEMS (FORMERLY MARLBOROUGH STIRLING MORWEB).................. 251 8.6.1.3 MORTGAGEBOSS™..................................................252 8.7 MORTGAGE DEFAULT INSURANCE.....................................................253 8.7.1 OBTAINING MORTGAGE INSURANCE...................................254 8.7.2 TECHNOLOGY SYSTEMS FOR MORTGAGE INSURANCE.....257 8.7.2.1 ELEMENTS OF THESE SYSTEMS.............................257 8.7.2.2 ADVANTAGES OF THESE SYSTEMS........................260 8.8 MORTGAGE CREDITOR INSURANCE...................................................260 8.8.1 THE NEED FOR MORTGAGE CREDITOR INSURANCE..........262 8.9 TITLE INSURANCE.................................................................................265 8.9.1 TITLE INSURANCE POLICIES..................................................269 8.9.2 TITLE INSURANCE PROTECTION...........................................270 8.9.3 DUTIES OF TITLE INSURERS...................................................270 8.9.4 POLICY STRUCTURE...............................................................272 8.9.4.1 COVERAGE STATEMENT..........................................273 8.9.4.2 COVERED TITLE RISKS.............................................273 8.9.4.3 EXCLUSIONS.............................................................273 8.9.4.4 KNOWN DEFECTS.................................................... 274 8.9.4.5 OTHER FEATURES.................................................... 274 8.9.4.6 CLAIMS.....................................................................275 8.10 HOMEOWNERS INSURANCE...............................................................277 8.10.1 PROPERTY INSURANCE..........................................................278 8.10.2 LIABILITY INSURANCE............................................................278 8.10.3 INSURANCE FOR PERSONAL BELONGINGS.........................279 8.10.4 ADDITIONAL INSURANCE......................................................279 8.10.5 INSURANCE FOR CONDOMINIUMS......................................280 8.10.6 INSURANCE FOR COMMERCIAL BUILDINGS........................280 8.11 CHAPTER REVIEW.....................................................................................281 SUMMARY..............................................................................................281 KEY TERMS........................................................................................................283 APPLICATION EXERCISES.................................................................................284 Table of Contents xi MODULE NINE APPRAISALS............................................................................. 287 9.1 LEARNING OBJECTIVES........................................................................287 9.2 INTRODUCTION....................................................................................287 9.3 WHAT IS FAIR MARKET VALUE?...........................................................288 9.4 WHAT IS AN APPRAISAL?.....................................................................289 9.5 TYPES OF APPRAISALS.........................................................................290 9.5.1 SALES DATA REPORT..............................................................290 9.5.2 LIMITED-RESTRICTED APPRAISAL.........................................291 9.6 INFORMATION FOUND IN THE APPRAISAL.......................................293 9.6.1 PROPERTY IDENTIFICATION..................................................293 9.6.2 PROPERTY AND NEIGHBOURHOOD.....................................294 9.6.3 SITE DESCRIPTION..................................................................295 9.6.4 IMPROVEMENTS - EXTERIOR.................................................297 9.6.5 IMPROVEMENTS - INTERIOR..................................................298 9.6.6 SCOPE OF THE REPORT & DEFINITIONS...............................300 9.6.7 ASSUMPTIONS, LIMITING CONDITIONS, DISCLAIMERS AND LIMITATIONS OF LIABILITY............................................301 9.7 APPROACHES FOR CONDUCTING APPRAISALS................................302 9.7.1 DIRECT COMPARISON APPROACH........................................302 9.7.2 COST APPROACH....................................................................305 9.7.3 INCOME APPROACH...............................................................306 9.7.4 RECONCILIATION AND ESTIMATE OF VALUE.......................307 9.8 DESIGNATIONS.....................................................................................307 9.8.1 AIC ETHICS STANDARDS........................................................308 9.8.2 AIC STANDARD.......................................................................309 9.9 AUTOMATED VALUATION MODELS................................................... 311 9.9.1 OTHER METHODS OF DETERMINING VALUATION.............. 311 9.9.2 BENEFITS OF AVMS................................................................. 311 9.10 THE UNDERWRITING DECISION.......................................................... 312 9.10.1 REVIEWING THE APPLICATION.............................................. 313 9.10.2 REVIEWING THE APPRAISAL REPORT................................... 314 9.10.3 THE UNDERWRITING FACTORS............................................. 315 9.10.4 UNDERWRITING OUTCOMES................................................. 315 xii Introduction to the Canadian Mortgage Industry, Sixth Edition 9.11 CHAPTER REVIEW................................................................................. 317 SUMMARY.............................................................................................. 317 KEY TERMS........................................................................................................ 319 APPLICATION EXERCISES.................................................................................320 MODULE TEN THE CLOSING PROCESS.......................................................... 323 10.1 LEARNING OBJECTIVES........................................................................323 10.2 INTRODUCTION....................................................................................323 10.3 COMMITMENT LETTER.........................................................................325 10.4 INSTRUCTIONS TO LAWYERS..............................................................328 10.5 DOCUMENTATION PRIOR TO LENDER ADVANCING FUNDS............329 10.5.1 SURVEY....................................................................................329 10.5.2 LAWYER’S REPORT ON TITLE.................................................330 10.5.3 TITLE INSURANCE...................................................................330 10.5.4 STANDARD CHARGE TERMS..................................................330 10.5.5 ADDITIONAL AND SUPPORTING DOCUMENTS...................332 10.6 DISCLOSURE..........................................................................................332 10.6.1 DISCLOSURE REQUIREMENTS FOR STANDARD MORTGAGE TRANSACTIONS.................................................333 10.7 DISBURSEMENT OF FUNDS.................................................................333 10.7.1 MORTGAGE FILE CREATION...................................................334 10.7.2 INTEREST ADJUSTMENT DATE...............................................334 10.8 FINAL DOCUMENTATION.....................................................................334 10.9 REGISTRATION......................................................................................335 10.10 MORTGAGE SERVICING........................................................................335 10.11 PROPERTY TAX PAYMENTS..................................................................337 10.12 RENEWALS.............................................................................................338 10.13 ARREARS COLLECTION........................................................................338 10.14 REPAYMENT AND DISCHARGE............................................................339 Table of Contents xiii 10.15 CHAPTER REVIEW.................................................................................340 SUMMARY..............................................................................................340 KEY TERMS........................................................................................................342 APPLICATION EXERCISES.................................................................................343 MODULE ELEVEN PROTECTING CONSUMERS AND INCREASING INDUSTRY PROFESSIONALISM................... 349 11.1 LEARNING OBJECTIVES........................................................................349 11.2 INTRODUCTION....................................................................................349 11.3 MORTGAGE FRAUD..............................................................................350 11.3.1 CANADIAN FRAUD LOSSES.................................................... 351 11.3.2 WHY IS FRAUD BECOMING MORE COMMON?....................352 11.3.3 WHY DO PEOPLE COMMIT MORTGAGE FRAUD?................354 11.3.4 CLASSIFICATION SYSTEM FOR MORTGAGE FRAUD...........356 11.3.5 RED FLAGS FOR FRAUD........................................................363 11.3.6 INITIATIVES TO FIGHT FRAUD...............................................364 11.3.6.1 INITIATIVES UNDERTAKEN BY MORTGAGE INDUSTRY ASSOCIATIONS...............364 11.3.6.2 INITIATIVES UNDERTAKEN BY MORTGAGE INDUSTRY PARTICIPANTS.365 11.3.6.3 INITIATIVES UNDERTAKEN BY REGULATORS........365 11.3.7 ORIGINATION STANDARDS...................................................366 11.4 RAISING PROFESSIONAL STANDARDS...............................................368 11.5 CONSUMER PROTECTION LAWS.........................................................370 11.5.1 THE PERSONAL INFORMATION PROTECTION AND ELECTRONIC DOCUMENTS ACT (PIPEDA)............................371 11.5.2 CONSUMER REPORTING ACTS.............................................372 11.6 ADVERTISING STANDARDS..................................................................373 11.7 MARKETING TO MEET CONSUMERS’ NEEDS.....................................377 11.7.1 CANADIAN ANTI SPAM LAW (CASL)......................................379 11.8 ERRORS AND OMISSIONS INSURANCE..............................................382 11.9 CHAPTER REVIEW.................................................................................383 SUMMARY..............................................................................................383 KEY TERMS........................................................................................................384 APPLICATION EXERCISES.................................................................................385 xiv Introduction to the Canadian Mortgage Industry, Sixth Edition APPENDIX 1 ANSWERS TO APPLICATION EXERCISES................................ 387 MODULE ONE...................................................................................................389 APPLICATION EXERCISES.....................................................................389 MODULE TWO..................................................................................................392 APPLICATION EXERCISES.....................................................................392 MODULE THREE...............................................................................................394 APPLICATION EXERCISES.....................................................................394 MODULE FOUR.................................................................................................397 APPLICATION EXERCISES.....................................................................397 MODULE FIVE...................................................................................................402 APPLICATION EXERCISES.....................................................................402 MODULE SIX.....................................................................................................404 APPLICATION EXERCISES.....................................................................404 MODULE SEVEN...............................................................................................406 APPLICATION EXERCISES.....................................................................406 MODULE EIGHT................................................................................................ 411 APPLICATION EXERCISES..................................................................... 411 MODULE NINE.................................................................................................. 414 APPLICATION EXERCISES..................................................................... 414 MODULE TEN.................................................................................................... 417 APPLICATION EXERCISES..................................................................... 417 MODULE ELEVEN.............................................................................................420 APPLICATION EXERCISES.....................................................................420 APPENDIX 2 MORTGAGE TERMINOLOGY................................................... 423 Table of Contents xv PART 1 The Mortgage Industry in Perspective Module One Overview of the Industry 1.1 LEARNING OBJECTIVES By the end of this module, you should be able to: ◗ Discuss the legal and financing history of mortgages in Canada. ◗ Understand the demand and supply factors that affect real estate. ◗ Identify and outline the primary mortgage funding sources in Canada. ◗ List the key players in the mortgage industry, and their roles and responsibilities. 1.2 INTRODUCTION Mortgage financing is a vital part of the Canadian economy. The Canadian mortgage industry has continued to grow and change over time, with new participants constantly entering the field, and new products being developed. According to the Bank of Canada, the total amount of residential mortgage credit outstanding in Canada (June 2023) was estimated to be about $2,118 billion representing almost 74% of total household credit. Introduction to the Canadian Mortgage Industry, Sixth Edition will: ◗ Place the mortgage industry in its historic, regulatory and legal perspective; ◗ Review the mathematics that is applicable to mortgage financing; ◗ Explain the mortgage process from the beginning (brokering the deal and taking a mortgage application) through the lender evaluation (the underwriting process) and on to the closing process; and ◗ Explain the professional standards and best practices that apply to various parties in the industry. 1.3 HISTORY OF THE MORTGAGE INDUSTRY While mortgages have existed for hundreds of years, the mortgage marketplace is not static, but rather continues to change and evolve over time. Almost every facet of the industry has changed in the past few decades from the length of term for a mortgage and the types of repayment options that are available, to the availability of funds, to the interest rates charged and to the sources of these funds. Module One | Overview of the Industry 3 i FOR YOUR INFORMATION A mortgage is a legal method by which a borrower (called the mortgagor) can pledge property to the lender (called the mortgagee) as security for a debt. As the requirements of both borrowers and lenders have become increasingly complex and diverse, mortgage lending practices, processes and procedures have evolved from that of a simple repayment plan to a multitude of complex payment arrangements offered by a wide range of public and private institutions. Today’s mortgage consumer has a wide array of mortgage choices available to them. The complexity of these choices can be confusing to the consumer. This growing diverse marketplace provides opportunities for brokerages and lenders to continually innovate the mortgage products they offer to stay competitive and to best meet the needs of their customers. 1.3.1 LEGAL HISTORY Mortgages have existed for hundreds of years although the mortgage, as we know it today, was only developed in the last century. Changes in the financing of land have been associated with changes in the ownership of land over time. Today’s mortgage industry can trace its origins to feudal times in England, when private ownership of land became more common. This came about as the power of Royalty and Lords diminished due to the growth and development of the middle class. In those times, just like today, the costs of property were high, and most purchasers needed financing of some kind. In order to facilitate the acquisition of land, loans secured by the right of ownership of the land became common. Under this initial system of mortgage lending, it was the seller (the vendor) of the land who supplied credit to the purchaser. No outside parties, such as banks, were involved. In many ways, this was similar to today’s vendor mortgage where the vendor sells a property and then “takes back” or holds a mortgage on the property. This system offered the vendor a considerable measure of security when agreeing to sell property, since the vendor kept the title to the property during the period that the mortgage loan was being paid off. Unlike today, 4 Introduction to the Canadian Mortgage Industry, Sixth Edition where the purchaser of a property can own and occupy a home until the mortgage is paid off, in feudal times the purchaser had no rights to the property until the loan was completely paid off. In addition, if the purchaser fell into arrears in the payment of the mortgage loan, the right to ultimately take possession of the property and any payments made on that property would become forfeit. This arrangement produced the term “mortgage,” which comes from the French words: mort, meaning dead or passive; and gage, meaning pledge. Land would be transferred to the purchaser only if certain conditions—like repayment of the debt—would be made. It was absolute, and remained in effect, regardless of whether the land being mortgaged could produce any crops or livestock that could be sold. This was in contrast to a “live gage.” A live gage was a pledge that was repaid solely from the “fruits of the land,” that is, from what could be generated by putting the land to use. The fruits of the crops or the livestock were given directly to the vendor, or the money from the sale of the produce or livestock was used to pay the debt. A mortgage, on the other hand, required no further steps to be taken by the vendor, such as acceptance of crops and livestock, for repayment of the debt—and thus it was “dead.” Gradually, as property ownership and mortgaging became more widespread, the separation between possession of the legal title and possession of the physical property became more distinct. First, it was recognized that the purchaser of a property who was granted a mortgage had the right to the profits from the land once it had been purchased. Once this was decided, there was no advantage to the vendor to retain possession of the property. The vendor’s income was seen to come from the interest payments resulting from the mortgage, rather than directly from the property in the forms of accepting crops or livestock raised on the property (the “live gage”). Vendors did retain possession of the legal title, thereby holding the right to regain possession of the property if the mortgagor defaulted on the mortgage. Over time, the concept of equity of redemption developed. This held that the borrower had the right, for a limited period of time, to repay the loan and retain possession of a property even if default had taken place. This acknowledged that the borrower was the owner of the property, and the lender merely held the right to obtain possession of the property if the borrower was unable to repay the borrowed funds. This concept holds true today. Module One | Overview of the Industry 5 1.3.2 FINANCIAL HISTORY While the previous changes in mortgages involved the evolving concept of who owned the land while the mortgage was being repaid, the twentieth century saw changes in how a mortgage loan was calculated. Initially, mortgage financing was characterized by long-term loans where nothing but monthly interest was paid over the life of the loan. When the loan reached the end of its term (known as its maturity), the main principal amount (the amount that was borrowed) was either repaid or refinanced with another mortgage. These are known as “interest only” mortgages. Again, this type of arrangement gave great security to the lender. The borrower’s income was regarded as security for the ongoing interest payments, while the property itself served as security for the principal. From the borrower’s viewpoint, the “interest only” repayment plan minimized the cash outlays and allowed for the establishment of a savings account to build toward the eventual repayment of the principal. Periods of stable interest rates, low inflation and stable property values resulted in these interest only mortgage loans being generally regarded as safe and satisfactory investments. The economic collapse of the North American economy during the late 1920s and early 1930s changed the perception of these interest-only mortgage loans. During the depression, many lenders found themselves with loans made to individuals who now had no income and whose property was worth considerably less than the amount the borrower owed. It was during this time, many lenders realized the concept of principal risk associated with interest only loans. They were now at the end of the term of the loan, the full amount of the principal was still outstanding, and this amount was more than the value of the property. Finally the lenders were faced with a particular risk, the purchaser might refuse to pay the principal amount, and the lender would be left with a property worth less than the principal. The mortgage market responded to this newly understood risk by creating what we now think of as a mortgage. The most common form of these repayment plans was the long-term, fully amortized mortgage. In a fully amortized mortgage, each payment monthly payment made by a borrower, is the same for the life of the mortgage and is comprised of interest due plus a partial repayment of principal. At maturity, rather than the full amount of principal being due, the full amount of principal has already been fully repaid during the term. This form of repayment was the rule in mortgage lending, particularly in the residential sector, from the end of the depression to the early 1970s. 6 Introduction to the Canadian Mortgage Industry, Sixth Edition Another major innovation during this same time (post-depression to the early 1970s) was the development of mortgage default insurance. In Canada, this came from the federal government’s attempts to stimulate the demand for, and supply of, housing during the post-World War II period. As direct federal intervention in housing is prevented by the Canadian Constitution (and formerly by the British North America Act), the federal government used indirect measures, primarily through the mortgage market, to implement its housing policies. To increase the supply of mortgage money, the federal government attempted to motivate financial institutions to increase the extent of their participation in mortgage lending, particularly by reducing the risk of their loss in the event of default. One method that is still in use today took the form of government insurance against default on mortgage loans granted under the terms of the National Housing Act (NHA). In 1946, a Crown Corporation known today as the Canada Mortgage and Housing Corporation (CMHC) was established to administer the National Housing Act (NHA). Under this insurance plan, borrowers paid insurance fees into a fund established and managed by the CMHC (and later private insurers) to compensate lenders when default occurred. The insurance program played a major role in attracting new lenders to the mortgage market, particularly the chartered banks, who were allowed to offer mortgages made under the National Housing Act under amendments to the Bank Act of 1954. Before this time, banks were not permitted to make any mortgage loans, except for those under the Farm Improvement Loans Act. The mortgage insurance market has changed and broadened dramatically since 1954. Originally, only National Housing Act (NHA) mortgages were eligible for insurance and only for properties that were single-detached homes or for new rental housing. By 1966, existing homes became eligible for insurance under the NHA. For the next four decades the NHA continued to evolve resulting in the following: ◗ All loans, whether fixed rate or variable rate, would now qualify for default insurance. As of 1980, it included mortgage loans with terms as short at 1 year. ◗ Down payment amounts were reduced to a minimum of 5% for a home purchased under the First Home Loan Insurance Program. ◗ In 1992, the federal government introduced the use of RRSP funds as down payment for an owner occupied home. Module One | Overview of the Industry 7 ◗ Mortgage insurance premiums were reduced by 15% in 2003 and reduced again in 2005. ◗ The maximum ceiling price for home mortgages was eliminated. ◗ Amortization terms had increased to 40 years by 2006. ◗ In 2007, loan to value ratio which required mortgage default insurance was increased from 75% to 80%. This meant the borrower only needed 20% as a down payment and not 25%. Other significant note in the history of Canadian mortgages is the addition of two additional default insurers: ◗ 1995 – GE Capital enters the market and later changes their name to Sagen™. ◗ AIG UG, a US insurance company enters the market in 2007. Just a few years later, it is sold to Canadian investors and the name changes to Canada Guaranty. In today’s mortgage market, CMHC, Sagen™ and Canada Guaranty provide default insurance to protect lenders for borrowers for the purchase of a new or existing homes for their primary residences, and for the purchase of a second home. In 1998, the maximum 95% loan-to-value ratio for first-time homebuyers was removed. In 2007, the loan-to-value ratio which required mortgage default insurance was increased from 75% to 80%. The maximum amortization period for government-backed mortgages was set at 40 years in 2006; it was lowered to 35 years in 2008, and now, is back at 25 years. At the same time, the maximum loan-to-value ratio was reinstated at 95% down from 100%. In 2010, the federal government instituted a requirement that, to be insured, mortgages with terms of less than five years must be qualified using the higher interest rates used on five-year terms. They also lowered the allowable loan-to-value on refinanced mortgages from 95% to 90% and required a minimum down payment of 20% on non-owner-occupied residential rental properties (1-4 units). In 2003, both CMHC and SagenTM (which had entered the Canadian mortgage insurance market in 1995 under the name GE Capital and later changed their name to Genworth Canada) reduced mortgage insurance premiums by 15% and eliminated the maximum price ceiling for home mortgages. In 2005, they provided further reductions in premiums. Mortgage loans remained relatively unchanged between the early 1950s and the late 1960s. The rise in inflation rates at the beginning of the 1970s, however, brought about changes to the entire Canadian economy, including 8 Introduction to the Canadian Mortgage Industry, Sixth Edition the mortgage market. As mortgage rates climbed sharply, mortgage lenders found themselves locked into lending money for long periods of time at rates which were far below the current rate. For example, a lender committing to a conventional mortgage of 9% in January of 1972 found that only three years later they were in an environment of rates that stood at 11.8%. While such a change in interest rates over a three-year period may not seem to be very significant today (given interest rate changes in the 1980s and 1990s), this rise in interest rates came as a shock to lenders who were used to very few interest rate changes during the 1950s and 1960s. See Figure 1.1. Figure 1.1: Prime Mortgage Rate History Historical Prime Mortgage Rates from 1935 - Today 25% 20% 15% 10% 5% 0% 1940 1950 1960 1970 1980 1990 2000 2010 2020 Source: RateHub.ca Note: The Prime rate is the basis for all variable morgage rates in Canada. If prime increases, your mortgage rate increases. If you'd like to access the data for the charts you can download that here. Because of these changing interest rate environments, mortgage agreements were changed to give both borrowers and lenders increased protection against the risk of unexpected interest rate fluctuations. The partially amortized mortgage, which offers such protection, became the most common form of mortgage loan. This form of repayment plan calculates periodic payments (such as monthly payments) of both the principal and interest over a long period of time (such as 20 or 25 years), at which point the balance would be $0.00. This is referred to as the amortization period. Module One | Overview of the Industry 9 However, the loan term is set for a shorter period, such as one, two, three, five, or seven years. For the term of the mortgage, the interest rate, and all conditions of the mortgage remain the same. At the end of this mortgage term, referred to as the maturity date, the full amount of the outstanding balance must be repaid or refinanced at a new/current rate, payment amount and conditions. To follow this example further, a mortgage that will has an amortization period of 25-years, may have a mortgage term (with a set interest payment) of only five years. At the end of this five-year period, the remaining balance will then be amortized for the remaining 20 years. It is at this maturity date the borrower can then chose to either pay off the mortgage, select a new term with the existing lender, or switch their mortgage to a different lender offering better rates and conditions that meets the borrower’s current needs. This partially amortized mortgage permits both lenders and borrowers to share the risk of possible fluctuations in the long-term lending rate. Government actions during this same period beginning in the 1970s focussed on expanding housing options for a broader range of Canadians. A growing range of programs sought to either build or help finance housing for particular groups, such as seniors and low income households. The federal government has also taken steps to stabilize the flow of mortgage funds by attempting to attract more investors to the mortgage market. In 1986, CMHC created a new financial instrument called NHA Mortgage-Backed Securities (MBS). Mortgage-Backed Securities were designed to help provide a steady flow of mortgage funds into housing in Canada (see Section 1.5 of this chapter, Mortgage Funding Sources, for more information). Canada Mortgage Bonds (CMB) were introduced by CMHC in 2005; these are similar to Mortgage-Backed Securities, but do not allow for prepayment so investor returns are more predictable. In 1992, the federal government introduced the Home Buyers’ Plan in order to help individuals buy a home. It allows most Canadians to borrow up to $25,000 from their Registered Retirement Savings Plans (RRSPs) on a tax-free basis to purchase a first home; they are required to repay this loan over a 15-year period to replenish their RRSP or pay tax on the amount not repaid. Since then, millions of Canadians have participated in the program. The following information will provide information for changes in this program since its inception. 10 Introduction to the Canadian Mortgage Industry, Sixth Edition In 2007 and 2008, the United States, along with the rest of the world, was faced with what is now referred to as “The Financial Crisis of 2007- 2008”. Excessive risk-taking by banks, combined with a downturn in the US subprime lending market, lead to several major banks facing bankruptcy. The crisis sparked a global recession, which was the most severe recession since the Great Depression, during the 1930’s. During this financial crisis, the Canadian financial picture appeared to fair much better than many countries, and home prices did not drop as dramatically as they did in the US. In order to keep the Canadian banks and housing market from duplicating the US situation, the Canadian government began implementing initiatives, to prevent any further decline, and create a more conservative approach to the previous riskier lending rules. Recent government initiatives include: 2008: Lowering the maximum amortization period for insured mortgages from 40 to 35 years (later amended). Minimum of 5% down payment now required (later amended). 2010: Insured mortgages with terms less than five years required to qualify at the 5-year benchmark rate (referred to as the qualifying rate). Lowering the maximum loan-to-value ratio for insured refinanced mortgages from 95% to 90% (later amended). Requiring a minimum 20% down payment for insured non-owner occupied residential properties (1-4 units). 2011: Reducing the maximum amortization period for insured mortgages to 30 years (later amended). Home Equity Lines of Credit (HELOCs) no longer qualify for default insurance. 2012: Maximum amortization period for insured mortgages reduced to 25 years. Reduce the maximum loan-to-value ratio for insured mortgage refinances to 85% (later amended). Maximum Gross Debt Service (GDS) Ratio to 39% and the maximum Total Debt Service (TDS) Ratio to 44% (for borrowers with credit scores of 680+). Set a maximum purchase price for properties to be eligible for mortgage default insurance to one million dollars. Module One | Overview of the Industry 11 2016: Adjust the minimum down payment requirement for insured mortgages for properties over $500,000—a 5% down payment is required on the first $500,000, and a 10% down payment is required on the amount above $500,000 (properties over $1 million are not eligible for mortgage default insurance). E.g.: Purchase price is $800,000.00 Amount on first $500,000.00 = $ 25,000.00 Amount on remaining $300,000.00 = $ 30,000.00 Total Down Payment needed $ 55,000.00 ll insured mortgages must now be stress tested using the 5-year A posted rate (qualifying rate). 2017: Financial institutions are no longer allowed to arrange, or appear to be arranging a mortgage, or combination of mortgages (a 1st and 2nd mortgage), referred to as a “bundle”, that would circumvent the maximum LTV ratio for that property, as outlined in the lender’s underwriting policies. 2018: All uninsured (conventional) mortgages must qualify using the higher of the contracted mortgage rate + 200 Bps, or the 5-year benchmark rate published by the Bank of Canada (see: https://www.mortgagedashboard.ca/en/home). 2019: The RRSP withdrawal limit under the Home Buyers’ Plan is increased to $35,000 from $25,000. CMHC to provide an incentive to first-time buyers: 5% of the purchase price for existing homes and 10% for new builds – through a shared equity program. This is for default-insured purchases only with borrowers who have annual household income of less than $120,000. The mortgage plus the incentive, cannot exceed four times the participants’ annual household income. 2020: CMHC implements changes to GDS and TDS ratios that took effect July 1, 2020: ◗ Lowering the maximum GDS ratio from 39 to 35 ◗ Lowering the maximum TDS ratio from 44 to 42 12 Introduction to the Canadian Mortgage Industry, Sixth Edition ◗ least one borrower in the household must have a minimum credit At score of 680 ◗ Borrowed down payments will no longer be allowed (some exceptions may apply) i FOR YOUR INFORMATION CURRENT requirements for insured mortgages (as of print date of this textbook): General ◗ Mortgage insurance is required for mortgages over 80% LTV (down payment of less than 20%). ◗ Maximum purchase price allowable is $1,000,000 (properties purchased at over $1 million are not eligible for mortgage default insurance). Minimum Down Payment ◗ For owner-occupied properties with 1-2 units below $500,000, 5% ◗ For owner-occupied properties with 1-2 units above $500,000, 5% for the first $500,000 and 10% for the amount above $500,000 ◗ For owner-occupied properties with 3-4 units, 10% ◗ For non-owner occupied properties, 20% Loan Parameters ◗ Maximum amortization period allowed is 25 years ◗ Maximum amount that can be borrowed for refinance is 80% of the property value ◗ Maximum debt servicing ratios allowable with Sagen™ and Canada Guaranty (for credit scores 680+) are: GDS = 39%, TDS = 44% ◗ Maximum debt servicing ratios allowable CMHC (for credit scores 680+) are: GDS = 39%, TDS = 42% Qualifying Rates ◗ All uninsured (conventional) mortgages must qualify using the higher of the contracted mortgage rate + 200 Bps, or the 5-year benchmark rate published by the Bank of Canada. ◗ All insured mortgages must be stress tested using the 5-year posted rate (qualifying rate). Module One | Overview of the Industry 13 1.4 MARKET SIZE AND TRENDS As large as the residential mortgage market is in Canada, it continues to expand and grow. According to Statistics Canada, the total amount of residential mortgage credit outstanding in Canada has grown by approximately $490 billion between December 2019 and June 2023, an increase of almost 3%. During the past decade, the market has experienced relative instability due to global and national market pressures such as the COVID-19 pandemic, and an unprecedented rise in interest rates. In 2021, Mortgage Professionals Canada's Chief Economist, Will Dunning, decided to forego all forecasting. In 2023, things have changed again with increased interest rates and increased immigration pushing up demand where supply was already low. To learn more about the effects of the COVID-19 pandemic and other recent events, please refer to the mortgageproscan.ca website. Figure 1.2: Residential Mortgage Credit in Canada Growth of Household Mortagage Credit in Canada 16% 14% 12% % Year-Over-Year 10% 8% 6% 4% 2% 0% 1990 1995 2000 2005 2010 2015 2020 Source: Statistics Canada Based on data from Statistics Canada’s 2021 Census and MPC consumer reports released in March of 2021, there are approximately 14.98 million households in Canada. This includes: 14 Introduction to the Canadian Mortgage Industry, Sixth Edition ◗ 10.01 million homeowners, of whom 6.08 million have mortgages. Of these, 1.72 million also have Home Equity Lines of Credit (HELOCs) and 4.36 million have a mortgage without a HELOC. ◗ 3.93 million homeowners have no mortgages. Of these, 290,000 have HELOCs and 3.64 million have neither a mortgage nor HELOC. ◗ Combining data on two groups of HELOC holders (with and without other mortgages), about 2.01 million homeowners have a HELOC. ◗ There are about 4.92 million tenants. ◗ 60,000 households are living in band housing. Figure 1.3: Estimated Households in Canada Estimated Households in Canada, Year End 2020 Owned with Mortgage + HELOC, 1,720,000 Owned no Mortgage, with HELOC, 290,000 Owned with No Financing, 3,640,000 Rented, 4,920,000 Band Housing, 60,000 Owned with Mortgage, 4,360,000 As large as the residential mortgage market is in Canada, it continues to expand and grow. Residential mortgage credit expanded 7.1% year-over-year. Typically economists have been able to make forecasting predictions on changes within the market, however with the drastic changes that occurred during the COVID-19 pandemic, this became extremely difficult. From the Semi-Annual State of the Housing Market Report by MPC, 2023: 1. As of 2023, the share of mortgage owners considering selling because they cannot afford their current mortgage surged more than three-fold, to 7% from just 2% a year ago. Nearly three-quarters (72%) of first-time homebuyers say interest rates are already having a material impact on their situation. 2. 65% of respondents will have to renew their mortgages in the next three years with 1-in-5 (19%) expecting to do so over the next year. More than two-thirds (69%) said that they are anxious about renewing with higher rates. Module One | Overview of the Industry 15 3. Half (48%) of non-owner respondents say they will never purchase a primary residence. 4. Three-quarters (77%) of non-owners say they will change their home buying plans due to higher interest rates; 30% say they will delay plans to purchase altogether. 5. The mortgage broker share increased slightly to 31%. This percentage goes up to 44% among those who have purchased in the last two years and 42% for first-time buyers. Broker share is highest in Alberta, BC, and Ontario. Canada's historic house price correction is not over yet. The Bank of Canada’s recent rate hikes to 5.0% will cause mortgage rates to reach 6.1% in the second half of 2023, further impacting housing and affordability. As a result, the housing market downturn in Canada is now expected to extend into 2024 as the spring revival of resale housing comes to an end. House prices are predicted to fall by an additional 10% by early next year, resulting in a total decline of 20%-25% from the peak in February 2022. The market value of Canada’s housing stock should return to its current level by end of 2027. After a 3-year stall, mortgage credit growth in Canada is expected to see a modest rebound in 2025 supported by improved affordability conditions. Year-over- year growth is projected to average 4.7% from 2027 onwards. A Falling Home Ownership Rate in Canada Data from the 2021 Census shows that the home ownership rate has fallen in Canada. The 2021 rate of 66.5% was 2.5 points lower than the 69.0% rate for 2011. As is shown in this chart, home ownership rates fell quite sharply for the youngest (first-time buyer) age groups. For the three youngest age groups, the drops between 2016 and 2021 were: 3 points, 2.7 points, and 3.1 points. Ownership rates fell for each older age group within this timeframe as well, whereas the 70 and over age group saw an increase in ownership between 2011 and 2016. 16 Introduction to the Canadian Mortgage Industry, Sixth Edition Figure 1.4: Canadian Home Ownership Rates by Age Group Younger Adults are Less Likely to Own Their Homes 80% 2011 2016 2021 60% Homeownership Rate (%) 40% 20% 0% 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 70-74 75-84 85 + Source(s): National Household Survey, 2011 (5,178), and Census of Population, 2016 and 2021 (3,901). Figure 1.5: Residential Mortgage Credit by Lending Institution Residential Mortgage Credit by Lending Institution (2018) Chartered banks Trust and mortgage loan companies Non-depository credit intermediaries and others Credit unions and caisses populaires Pension funds National Housing Act mortgage-backed securities (NHA MBS) Source: Statistics Canada (CANSIM) In the first three quarters of 2013, over $1.5 million mortgage loans were approved across Canada for a total amount of about $218 billion. Module One | Overview of the Industry 17 The chart below illustrates the relatively flat mortgage activity during the second half of the 1990s compared to the sharp rise during the past decade. Total approvals for 2008, at $216 billion, are about three times the volumes seen during the second half of the 1990s. Figure 1.6: Share of number of loans originated $450 Year-to-date mortgage origination: Insured and uninsured, all items $400 $350 $300 $ Billions $250 $200 $150 $100 $50 $0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: NBF, BoC / Note: YTD is through August 1.4.1 MORTGAGE TRENDS – MORTGAGE SURVEY Mortgage Professionals Canada has conducted market research on the behaviours and attitudes of Canadian mortgage consumers for many years. Two major reports are produced each year. Both are based largely on surveys of Canadian consumers. The fall report generally reviews the state of the Canadian residential mortgage market, reviewing recent trends and providing forecasts for future activity in the housing and mortgage markets. The spring reports generally profile choices made by consumers in the mortgage market. 18 Introduction to the Canadian Mortgage Industry, Sixth Edition Table 4.1 and 4.4 outlines responses to questions in this survey: Table 4-1 Summary of Consumer Responses to Topical Question, by Year of Survey (Average Scores on a Scale of 1 to 10) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Low interest rates have meant that a lot of Canadians became homeowners over the 6.88 7.11 7.01 7.04 6.98 6.80 7.03 7.15 6.76 6.76 6.68 past few years who should probably not be homeowners. I regret taking on the 3.86 4.04 3.88 3.82 3.89 3.67 3.60 3.67 3.37 3.81 3.62 size of mortgage I did. I/My family would be well-positioned to weather a potential 6.54 6.72 6.67 6.93 6.95 6.92 7.02 7.09 7.02 6.81 6.93 downturn in home prices. Real estate in Canada is a good long-term 7.13 7.27 7.26 7.44 7.35 7.37 7.17 7.15 7.22 7.34 7.29 investment. I am optimistic about the economy in the N/A 6.02 6.13 6.36 6.25 6.23 5.99 6.26 6.01 6.05 5.67 coming 12 months. I would classify mortgages N/A 7.07 7.05 7.20 7.15 7.06 7.02 6.94 6.87 7.09 6.98 as "good debt". I/My family would be well-positioned to handle a potential N/A N/A N/A N/A N/A N/A N/A N/A N/A 6.36 6.44 increase in mortgage interest rates. As the result of COVID-19, I am anxious about my/my family's N/A N/A N/A N/A N/A N/A N/A N/A N/A 5.14 5.14 financial situation over the next few months. Source: Mortgage Professionals Canada survey, Fall 2010 to Year-End 2020; Estimates by author. Module One | Overview of the Industry 19 Table 4-4 Happiness with Decision to Buy a Home, by Period of Purchase Pre-1990 1990s 2000-2004 2005-2009 2010-2013 2014-2017 2018-2021 All Periods I am happy with 95% 95% 93% 90% 90% 87% 91% 90% my decision. I regret my decision - I wish I did not 0% 1% 1% 3% 3% 5% 3% 4% choose to own a home. I regret my decision - I wish I had 5% 4% 6% 7% 7% 8% 6% 7% purchased a different home/ property. Total 100% 100% 100% 100% 100% 100% 100% 100% Source: Mortgage Professionals Canada, survey, End of year of 2020; analysis by the author. Note: Totals may not add to 100% due to rounding. 1.5 UNDERSTANDING REAL ESTATE AND MORTGAGE FUNDING The previous section has described the size of the mortgage market in Canada. Mortgages, however, are just a part of the overall real estate market. It is important for a mortgage broker to understand the social and economic factors that affect real estate, because it is the land and the buildings on it that form the basis of the mortgage agreement and provide security for the loan. The demand for housing is affected by a complex synthesis of demographic factors, economic factors and consumer preference factors. The way that these factors interact with each other results in changes in the characteristics of households and what they demand in a house. All of this leads to countless opportunities for a mortgage broker because a household can move, change houses and vary its composition over its lifetime. This section concludes with a look at the available sources of mortgage funding. 1.5.1 THE FACTORS AFFECTING REAL ESTATE While there are many approaches to understanding the real estate market, the traditional way is to look at real estate in the same way that other commodities (from oil to food) are examined: in terms of supply and demand. 20 Introduction to the Canadian Mortgage Industry, Sixth Edition Supply means the total number of housing units that are available for purchase in a given area at a particular point in time. Demand refers to the number of households who both wish to purchase housing and have the financial means to do so. 1.5.1.1 DEMAND Demand for housing is affected by a number of factors. The complex interaction of these factors in an area is what produces the total demand for housing. These factors include: ◗ Demographics – the age, income, sex, education, occupation, and other relevant characteristics of the population ◗ Economics – broad economic forces affecting interest rates and growth in the economy ◗ Consumer Choice – the types of housing people prefer to occupy Demographics The basic demographic variables are population size and population growth. Generally speaking, the greater the population, the greater the demand for housing will be. Population growth results from two factors: natural growth (resulting from the number of children being born); and immigration (people moving into an area) and emigration (people moving away from an area). When looking at natural growth, it is important to understand the dimension of time. For example, in Canada and in many developed nations, fertility rates are generally below replacement levels (at around 2.1 children per household). In other words, people are not having babies in sufficient numbers to eventually replace them in the population when they die. Therefore, population levels will increase as people have babies, but will then decline decades in the future as people die without there being enough growing children to “replace” them. However, this type of decline will not occur if the population grows because of other factors, such as immigration, which can offset the possible trend. Immigration and migration are very strong indicators of population growth, and therefore, of housing demand. The economically strongest regions in Canada tend to attract the most immigrants, and to a lesser extent, migrants from other parts of the country. For example, immigrants are drawn more strongly to southern Ontario rather than to the Maritimes. Thus, areas of growth are directly correlated to increases in the population and to boosts in the economy. Module One | Overview of the Industry 21 Many people consider Canada when deciding to relocate. As a result, Canada admitted roughly 260,000 immigrants in 2014. A number of other demographic variables also affect the housing market. For example, Canada’s slowly aging population is leading to an increased demand for seniors’ housing, and other assisted living options. The rate of what is known as household formation is even more important for those concerned with demand for housing. In housing economics, unlike general economic models, the basic unit of study is not an individual, but rather, the household. Households demand housing, with the general rule being one household per house. A household can be made up of an individual, a couple, or either one of these with children. Marriage and divorce rates have a great influence on household formation (a divorce, for example, creates two new households where there used to be one). Economics also affects household formation. In good economic times, an increasing number of households tend to form (for example, as grown children leave to form their own household). In slow economic times, by comparison, either the number of households stays the same or decreases as individuals “double up”: individuals find roommates or housemates, grown children move back in with parents, and seniors move in with their children. Economics Forces that affect the broad economy, as well as individual households, also affect the housing market. Because of the relatively high cost of real estate, few homes are bought without some financial assistance. This means that mortgages are needed for the vast majority of purchases. Low interest rates on those mortgages make housing more affordable, and thus, help to increase demand as home ownership becomes available to more people. The availability of credit (i.e., mortgage lenders’ willingness to lend money) also spurs housing demand. As was noted in Section 1.3.2, Canadian banks were not always allowed to make mortgage loans, a restriction that limited overall ability of households to purchase housing, limiting demand. A broad range of factors affect interest rates, such as the role of governments and business investment. Specifically, government deficits and booms in business investment raise the demand for capital, and thus, force up the price paid for that capital as reflected through interest rates. The Bank of Canada also has an impact through its raising and lowering of short-term interest rates. Inflation, which comes about when money is plentiful and is being circulated through the broad economy faster than goods and services can be produced to match it, also influences interest rates. Lenders will have to charge a greater interest rate on their loans to make up for the loss in the purchasing power of their money caused by inflation over the duration of the loan. 22 Introduction to the Canadian Mortgage Industry, Sixth Edition Inflation also increases the price of housing. Housing is seen as an inflation hedge, generally increasing in value to match overall inflation levels in the economy. The increasing price of housing resulting from periods of inflation and increasing interest rates, is usually viewed as a negative factor for housing demand. This is because households find that their savings are no longer sufficient to cover a down payment on a more expensive house and their wages may not be large enough to make mortgage payments resulting from higher interest rates on a mortgage loan. At the household level, economic factors including low unemployment levels and rising household incomes are all beneficial to housing demand. People with steady jobs and increasing incomes will have more money to spend on all items, including housing. Consumer Choice The type of housing that consumers demand is a function of demographics, economics, and a broad range of social and consumer preference variables. Households look for different types of housing as they age; perhaps beginning with rental housing, then moving to a starter home, then moving to a larger home to accommodate a growing family, and then finally trading down to a smaller condominium. Owning a home has been a strong consumer preference in North America for at least a century and there is no indication that this preference exhibited by many households will be changing any time soon. Economics is a very important factor in consumer choice. Generally, as households become wealthier, they tend to consume more housing, and of a higher quality. As household incomes increase, Canadians typically prefer owner-occupied housing to rental housing. Changes in consumer preferences are often reflected in where housing is produced in a city. After the Second World War, there was strong consumer preference in North America for new housing located in suburban areas. More recently, however, there has been a preference shown by some consumers (mostly the young and the “empty nesters”) for downtown or other prime areas in select cities, where housing is typically provided in the form of high-rise condominiums. Preferences may also be related to ethnicity. Some ethnicities have a greater preference for multi-generational living, for example, and might need more bedrooms and an extra kitchen. Furthermore, if a high concentration of that ethnic group moves to a particular community, the demand for larger housing will alter in that area. Module One | Overview of the Industry 23 1.5.1.2 SUPPLY A number of factors affect the supply of housing, including the demand factors noted above. For example, the demand factors that produced a preference for accessible downtown homes in larger cities spurred the creation of a supply of downtown condominiums. Government Governments can affect supply in many ways. As noted in Section 1.3.2, the federal government has acted on many occasions to make mortgage financing more plentiful, which helps to increase housing demand and allows builders easier access to financing during construction. Broader economic actions influenced by the federal government, such as policies to keep inflation and interest rates low while spurring economic growth, also positively affect housing demand and supply. Land-use regulations at the municipal level also affect housing supply. Land-use regulations in many areas either restrict or regulate the ability to add another unit on a property (e.g., the creation of a basement apartment or other form of second suite). They also restrict changes in the type of residential development allowed in an area (e.g., a single-family home is usually not permitted to be demolished and a high-rise residential condominium built in its place). Builders Housing supply is created by a large number of builders and developers across Canada, who are typically local, and usually produce or specialize in only one type of housing (e.g., “move-up” suburban homes, high-rise condominiums). Because of these characteristics of suppliers of housing, and the fact that it can take several years for housing to be produced (i.e., from the period that a developer purchases a piece of land, to the time it takes to achieve municipal approvals, and finally to construction and completion), supply and demand do not always match in the way that textbooks predict. In “hot” markets, there can be periods when there is not enough housing on-stream to meet current demand, resulting in existing housing being bid up in value. On the other hand, there are times when supply can be too great for the demand, as shown by the “condo glut” that many cities had in the early 1990s. Eventually, such periods of over-supply will lead to a lowering of prices, which will act to increase demand once again. 24 Introduction to the Canadian Mortgage Industry, Sixth Edition 1.5.2 MORTGAGE FUNDING SOURCES A key part of a mortgage originator’s job is being aware of all the available sources of mortgage funding. By understanding the full range of funding sources available in Canada, a mortgage broker can better understand the competitive environment to meet the needs of his or her clients. For mortgage lenders, a key part of the lender’s job is to recognize changes that are happening in the mortgage marketplace, and to create products that meet the needs of consumers. As we saw in Section 1.4, Figure 1.5: Residential Mortgage Credit by Lending Institution, the major sources of mortgage funds in Canada are the large financial institutions. These include banks (by far the largest supplier of mortgage funds), trust companies, credit unions and caisses populaires, life insurance companies, and mortgage and finance companies. Private individuals and governments tend to be thought of as secondary lenders, either meeting the excess demand for mortgage funds or investing in markets where the various financial institutions do not, or cannot, lend. 1.5.2.1 FINANCIAL INSTITUTIONS The difference among the financial institutions listed above comes about mostly as a result of government regulations. Banks are federally regulated and chartered according to the Bank Act. Trust companies can be incorporated and regulated at either the federal or the provincial level. Credit unions are regulated at the provincial level. Banks Chartered banks are currently the largest single source of institutional mortgage funds in Canada. At the end of Q2, in 2019, banks held about 74.5% of total residential mortgages. Their dominance results from their large market share in the residential mortgage field; their activity in non-residential mortgages, such as mortgages for commercial buildings, is not as dominant. The Bank Act recognizes and governs three distinct types of banks. Schedule I banks have shares that are widely held (by individuals who purchase shares on stock exchanges, and by groups, such as mutual funds and pension funds), with no shareholder permitted to own more than 10% of the bank’s shares. These domestic banks are authorized under the Bank Act to accept deposits, which may be eligible for deposit insurance provided by the Canadian Deposit Insurance Corporation (CDIC). Module One | Overview of the Industry 25 Schedule II banks are more closely held, either by a foreign bank that is a parent company, or by related financial institutions (such as American Express’s ownership of the Amex Bank of Canada). They are also authorized under the Bank Act to accept deposits. Schedule III banks are foreign bank branches of foreign institutions that have been authorized under the Bank Act to do banking business in Canada, though under restrictions. i FOR YOUR INFORMATION Selected Examples of Schedule I, II, and III Banks Schedule I banks include BMO Bank of Montreal, Citizens Bank of Canada, RBC Royal Bank, CIBC, Canadian Western Bank, Laurentian Bank of Canada, National Bank of Canada, Scotiabank and TD Bank Financial Group. Schedule II banks include Amex Bank of Canada, Citibank Canada, ICICI Bank Canada, Bank of China (Canada), HSBC Bank Canada, ING Bank of Canada and MBNA Canada Bank. Schedule III banks include ABN Amro Bank, Bank of America, Deutsche Bank and State Street Bank and Trust Company. The Office of the Superintendent of Financial Institutions (OSFI) oversees the operations of Banks in Canada. Much of the growth in market share of the chartered banks is a result of changing government regulations. One of the key changes to the Bank Act occurred in 1967. Until 1967 chartered banks were not allowed to charge interest rates on mortgages above 6% per year. For several years prior to this time (1960 to 1967), market interest rates were above 6%, resulting in banks being left out of the mortgage lending market. With market interest rates rising above 6%, no rational bank would lend money, because the maximum interest rate they were allowed to charge wa

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