Real estate pundits have been predicting the crash of Canada’s “overheated” real estate market (i.e. Toronto and Vancouver) for several years and with good reason. Cheap credit – mistaken for free money by borrowers – has encouraged a buying spree of not only homes but also cars, TVs, furniture, clothes and vacations. Borrowers swiped their plastic while holding their breath every time the Bank of Canada (BoC) made an announcement and leaving the Canadian government with an irreconcilable problem: how to cool an overheated real estate market by increasing interest rates without triggering a debt crisis? Enter the mortgage stress test.

 

The stress test was a logical solution – don’t increase rates, just make debt more difficult to obtain. This, in turn, will reduce demand. And it did. In fact, it did so well that housing-related markets (e.g. furniture stores, renovation companies) also took a financial hit and fund managers, such as Mr. Eisman, who shorted the US housing market before the 2008 crisis, renewed their interest in shorting the Canadian banks. Given the political and economic roller coaster we’ve been on, it comes as no surprise that interest rates have not gone up. This means that debt loads aren’t increasing, but buyers are still forced out of the market due to the test. It also means that Canadians may be turning to a much grayer, less regulated and problematic alternative – private lending.

 

What’s the Danger Behind Private Lending?

 

According to a January 2019 Financial Post article, private lenders make up about one-tenth of Canadas $1.5 trillion mortgage market. This is a problem for several reasons. Private lenders, for example, typically lend at a higher loan to value ratio and do not have to implement the same financial buffers required by our banks. This means that the risk which we believed was being carried by the banks is now on the shoulders of private lenders. If private lenders experience too many defaults, the fall of housing prices will accelerate and so will the overall economy. What is more, private lenders charge almost three times the interest rate as Canadian banks, making investors a healthy return while putting a buyer’s ability to service other debts in a precarious space. While regulation should be necessary and may be implemented in the space of private lending, it may be too late for loans already made.

 

What are the Solutions? 

 

An American company, PeerStreet, may be the perfect solution for Canadians. People interested in lending a minimum of $100.00 can become a part of the PeerStreet lending team. These “PeerStreet” lenders lend along with institutional investors and to buyers of property who follow a variety of screening tests. This lending platform, unlike private lenders, is more transparent because of its online presence and because they invest alongside established real estate companies. Bad policies and bad outcomes spread must faster online than behind the closed doors of private lenders. It also helps spread risk as the platform allows investors to expend minimal amounts that, if lost, would unlikely make a massive impact.  This wider spread of risk and transparency is needed in Canada, as the growing presence of private lending is the weakest link holding together the housing market and economy.

 

Written by Natalka Falcomer, JD, Vice President Corporate Development

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