Due to increasing interest rates and normalized demand, the Canadian real estate market is starting to show the first signs of stress. Canadian mortgage lenders will write down the most mortgages in over a decade during the third quarter of 2022. According to credit bureau statistics, this is currently not an issue since the percentage of mortgages written off continues to drop. Fewer new borrowers and less cash flow show that the drop in interest rates is just a delay.
Numerous misconceptions abound about losses and low default rates; therefore, let’s address this issue immediately. Loan losses indicate a lack of funds, not necessarily the borrower’s health. In a thriving market, anybody can acquire anything at any price, so a struggling borrower may be able to sell before defaulting. A seller must be pressured to sell and unable to find a buyer at the desired price for losses to grow. Low default rates are a sign of a bubble, but small increases aren’t always a reason to worry.
Currently, mortgage defaults in Canada are rising sharply. The average loss for the third quarter of 2022 was $96,000, an increase of 17.1% ($14,000) over the previous quarter. This is a 68.4% (or $39,000) increase compared to the same quarter last year. Since losses are experienced after the property’s value is taken into account, they tend to diminish as home prices rise. The last time it was this high was in 2015; thus, this trend needs serious observation.
The percentage of written-off mortgages continues to drop. In the third quarter of 2022, the rate fell to 0.03%, a fall of 0.01 percentage points from the previous quarter and a decline of 0.2 percentage points from the same time the previous year. This is the lowest quantity we’ve seen in at least a decade, and it’s a new record. The number is one of the lowest in decades.
Keeping in mind that liquidity is the most important lesson here, the data appear contradictory at first glance. On the one hand, the losses are growing, indicating that buyers are rejecting higher prices, as they often do when interest rates rise. People are defaulting before they can sell at a profit. Typically, this is accompanied by an increase in the default rate as consumers discontinue purchasing all available goods.
In addition, the percentage of mortgages ending in losses is falling. Some may even use the word “frothy” to describe an environment in which demand is very high. After just two consecutive quarters of escalating interest rates, a complete quarter of nonpayment is enough to declare default. Surely, as the number of new mortgages slows down, the number of mortgages that lose money will start to rise to a more manageable level.